Origin Enterprises plc (OIZ) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by and welcome to the Origin Enterprises plc 2020 Preliminary Results. [Operator Instructions]. And I must also advise you the conference is being recorded. I would now like to hand to your first speaker today, Sean Coyle, Chief Executive of the company. Please go ahead.

Thank you, Somar. I'd like to introduce a couple of my colleagues who are also here with me. We have Brendan Corcoran in the room here with me, who you know is our Head of Investor Relations. Brendan Kent is also here with me, who has recently been appointed Head of our Agri Imports division, and on the line from the U.K. is our colleague, Alex Steel, who has been recently appointed our Group Commercial Director. I'm delighted to be bringing the numbers to you this morning in what has been a very challenging year for Origin, principally driven because of weather. But we are delighted also to be delivering a reasonably significant operating profit in our sector when lots of other sectors are challenged by COVID. And we should also highlight the contribution that all of our staff are made continuing to maintain service right throughout the last 6 months, which have been challenging operationally for the business. A key highlight of the performance in the last 12 months has been the extremely strong cash flow. So we're delighted to see a strong working capital inflow from the business over the course of the last 12 months. And operationally, all of the businesses have contributed significantly to that cash inflow. I would say that our Central European businesses have certainly deemed the highlights amongst that, but all of the businesses have contributed significantly to that working capital inflow. In addition to that, obviously, we've had to suspend the final dividend, which is not great news for shareholders. But we've maintained significant discipline around cash spend, both from a CapEx perspective and also in a decision not to pursue the acquisition or increase in stake for our Ferrari Zagatto business, increasing the stake from 20% to 60% would have cost the group approximately EUR 10 million, and the decision not to pursue that has ultimately resulted in the founders of that business, repurchasing the 20% stake at par value from us. Managing through that has been challenging to say the least, and Declan Giblin, our CEO of the Latam business, has done a very good job in navigating the politics with the founders of that business who are, of course, shared with our Fortgreen business in Brazil. And it's good to see that our Latin American business has grown organically in that context. And finally, another key point, I suppose, is the build-out of the management team. So in addition to the individuals I've already introduced, we're very happy to announce that TJ Kelly is being announced today as our incoming CFO. He's got a strong track record in the industry. He worked with Glanbia under Performance Nutrition business for 12 years, both in a CFO role in the Performance Nutrition business and as Group Financial Controller with responsibility for Investor Relations in the PLC. So some of the highlights from a performance perspective in FY '20, we've talked already to the strong cash flow performance within the business, and a significant decrease in net debt from EUR 75.6 million down to EUR 53.2 million. So a good decrease in net debt at year-end, leaving us well positioned from a covenant perspective. Operationally, the business has performed well. There's been continued investment in CapEx projects for organic growth within the businesses, and that includes seed plants across the U.K., Poland and Romania. We've trebled our dry powder capacity within our Fortgreen business, doubled the capacity of Invergordon fertilizer plant, and continued investment in digital has allowed us to increase the hectares on that system from 1.2 million hectares to 1.4 million hectares at year-end. I've talked, I suppose, to the changes in the management team, but there are other strategic objectives ongoing. We have sold a couple of our properties, which are noncore assets within the business. Those will be completed in the current month, one completed yesterday and the other will complete before month end. And the gain on those properties is recognized within this set of numbers as they are assets held for sale at year-end. There's been very positive development of growth in our in-house micronutrition product range. Our product range, which is manufactured in Poland, then sold intra-group, has more than doubled in terms of intra-group sales in the last 12 months. So continuing to focus on production of our own product range is important to the business. We talked about our disposal of mistake in Ferrari Zagatto. From an environmental perspective, the fertilizer businesses have rolled out and are rolling out the nutri-cool-carbon calculator for their fertilizer. So we're in a position to be able to provide all farmers with the carbon footprint, the carbon usage of every ton of fertilizer that we sell-through the business. And finally, then we've invested again from a CapEx perspective in an R&D center for our amenity business at Throws Farm, which will showcase the product range within the amenity sector and also allow us to develop new products there. So from a business perspective, some of the highlights or some of the key parts of the moving parts within the year, have been decline in revenue from EUR 1.8 billion to EUR 1.6 billion within the year. That has resulted in a revenue mix across our segments. You can see there that Ireland U.K. has gone from 64% of revenue back to 61% of revenue, and corresponding profitability within that sector has moved from 73% of profits in the segment back to 53% of profits in the segment. So the Ireland U.K. segment has been the worst impacted by that change, principally driven because of weather, but a small element of it within the amenity business resulting because of COVID and the challenges associated with COVID on sports turf. Within the revenue decline and this number excludes crop marketing revenues and volumes, revenue at an overall level is back by 13.3%, and at an underlying level back by 13.5%, principally driven because of volume declines. Almost 11% of that is because of volume declines and about 2.8% of it largely driven because of changes within the fertilizer pricing dynamic over the course of the year. Most of the other categories that we sell, so seed and crop protection material, have maintained price levels year-on-year, largely maintained price levels year-on-year, so less than 1% slippage in any of those categories. Across each of the individual segments, a couple of things to highlight here. The operating margin within the Ireland U.K. business has declined from 5.2% to 2.4%, following the profit decline from EUR 60 million, EUR 23.3 million. So at an underlying level, a very significant drop in profitability across our Ireland U.K. business, driven by that volume reduction, and of course, that has been driven by the change in mix in planting as a result of the wet or the winter period that we experienced. The amenity sector has been curtailed by COVID-19 restrictions. And since year-end, thankfully, the amenity sector is seeing a lift in volumes, and we're seeing a successful uplift in volumes. However, we need to be cautious about that. Obviously, the U.K. is experiencing strengthening of restrictions again, following the second wave. So while we've had a very good 6 or 7 weeks post year-end within our amenity business, we are cautious about that sector in light of additional COVID-19 restrictions being introduced. Within our Continental European business, volumes backed very slightly at about 1.9%. And that's deliberately, I suppose, as a result of some of the disciplines that we've introduced from a working capital perspective. We have been very keen to try and restrict sales of low-margin commodity product. We've seen gross margin increase in all of our segments across CE. We've seen discipline applied to the selling pattern and also to, I suppose, the credit terms that we're giving within those businesses. Operating margin has improved in both Poland and Romania, and gross margin has improved within the Ukrainian business. So very keen to reward and say thank you to the people across those businesses who delivered good growth in those businesses from an operating margin perspective. But more importantly, showing that we are willing to sacrifice sales to an extent in order to drive better operating performance and better working capital discipline across those businesses. Our Latin American segment from an underlying perspective grew revenue by 6.4% and operating profit by 4.8% in the 12 months. However, there are challenges, I suppose, from a translation perspective in terms of how we report those business back into euro. We have seen capital investment in the dry powder capacity in that business over the last 12 months. And it's our intention to spend about EUR 1.5 million on a controlled release fertilizer plant in a more eastern state, north of São Paulo called Minas Gerais and that spend is planned over the coming 12 months to roll out the Fortgreen model from an organic perspective within the Brazilian geography. We've already touched on the disposal of our Ferrari Zagatto stake, and future M&A activity in a Latin American context will certainly be focused on the B2B channel rather than B2C. Very quickly, 1 or 2 numbers on this that we haven't already spoken about. Return on capital employed has obviously moved downwards in line with the reduced trading performance. And net debt excluding IFRS debt, which is about EUR 40 million has moved from EUR 75.6 million down to EUR 53.2 million, and that's the relevant number from a covenant perspective. So important to highlight that. Free cash flow, very strong at EUR 64.3 million stronger than a good operating profit performance year in 2019 at EUR 54 million. You can see the nature of the P&L here. And I suppose the group revenue performance and corresponding impact on group operating profit can be seen here with group operating profit down to EUR 44 million from EUR 82 million. Good contribution from our associates and joint ventures. That does include about EUR 400,000 of a contribution from our Ferrari Zagatto business in the year, which will be written off as part of the disposal of the Ferrari Zagatto business. And our financing costs, down year-on-year from EUR 11.8 million to EUR 11.3 million, and that includes the IFRS 16 interest charge of approximately EUR 1.7 million. So financing costs well down year-on-year on a like-for-like basis. You can see from the following charts that there's very little impact from either acquisitions or currency on the operating profit performance or revenue performance through the year. So a very limited impact and underlying performance is really shining through in the overall reported number. Operating profit impact from a currency perspective down by about EUR 1.6 million. And principally, that is the Brazilian business and translation of the performance of the Brazilian business back into Europe. Similarly, earnings per share largely unaffected by both acquisitions and currency and the broad thrust of direction of travel has resulted from the underlying performance within the business. An interesting slide on operating margin analysis. You can see that volume has driven principally the operating margin down. It is reduced from 4.6% to 2.8% over the course of the last 12 months. Volume being responsible for about 160 basis points of that drop. Fertilizer price deflation has been responsible for about 25 basis points of the reduction. We are seeing some cost savings, including bonus reductions, generating an upside of about 53 basis points. And others, including currency, have resulted in about 47 basis points of reduction. So the overall mix, largely driven by volume within the year. From a cash flow perspective, despite the fact that we've generated lower cash from operating activities within the 12-month period at a headline level, the inflow of working capital, reduced spend on interest and tax and reduced outlay in relation to historical exceptional and one-off items means that the net cash flow from operating activities is much increased from a much better performing year in 2019. Our balance sheet principal movements here include an increase in tangible assets, reflecting the nature of the IFRS 16 adjustments. Goodwill and intangible assets is principally a movement downwards, firstly, driven by currency, but secondly, driven by the brand write-offs of some brands which have gone through our exceptional items line in the year, totaling about EUR 5.7 million in terms of a write-off. Our working capital number has come down appreciably. And the difference between the EUR 30 million in the cash flow statement, and the EUR 40 million differential here is largely driven by FX. So important to point that the average FX rate for the year and the year-end FX rate has driven that difference in working capital numbers. From a deferred and contingent acquisition consideration perspective, still a EUR 25 million amount on the balance sheet at year-end, and that largely relates to the potential 2023 payment in respect of the balance of Fortgreen shares that we do not own. Net debt has increased to EUR 94 million when you include the IFRS 16 net debt, it was EUR 53 million, excluding that IFRS 16 figure. And overall shareholders' funds have declined year-on-year, principally because of the write-down in goodwill and intangible assets and the exceptional items, which have gone through there. From a banking perspective, again, using those metrics excluding the IFRS 16 number, net debt-to-EBITDA is just under EUR 1.2 million compared to just under EUR 0.9 million this time last year. So despite a very significant downward movement in the EBITDA level because of the operating profit falling, we are still seeing reasonable metrics at year-end. We do have to maintain discipline, though, between now and January, and we're still very focused on meeting the January covenant level. And as you all know, the covenant level at January is the more important metric to me. From a capital allocation perspective, the pausing of acquisitions is well flagged at this stage. We did announce in June that we will be suspending our final dividend because of that pressure that the EBITDA number is under due to trading in the current year. And obviously, we've been minimizing CapEx where at all possible in terms of reducing spend. So lots of activity ongoing to ensure that the covenant number will be met as the half year days of January. From a strategic perspective, we are, I suppose, saying it today, and coming back to the point today that the 2023 ambition is still intact. We still believe that we can deliver on the 5% to 9% EBIT CAGR that we flagged at our Capital Markets Day in 2019 of the 2018 base. And that will come about because of organic growth across Ireland, U.K., Continental Europe and Latin America and also an element of acquired growth within that period. So we do believe that the key metrics that you can see below in terms of return on investment capital. The free cash flow ratio, the changing of product mix within the portfolio, which has had an encouraging start. And I think Alex can talk to that a little bit later on in the Q&A section. And optimizing our route to market in terms of our product based capability and our digital platform. That's hugely important in terms of driving those returns over the next 3 years. Brexit remains in focus for the group. And there are a number of challenges coming at us. We don't see any immediate challenge in terms of any of the logistical or financial hedging elements associated with a hard Brexit at the end of the transition period in December. So we have mitigations in place and contingency plans in place in relation to security of our supply chain. We have very limited cross-border activity and where it exists. We've secured authorized economic operator status or indeed permissions for export activity where it's required. But by and large, the large focus or the predominant focus of any Brexit challenge will be longer term. What are the implications for the Irish agriculture sector, what are the implications for the U.K. agricultural sector following Brexit. And I think if anything, COVID-19 has brought home to the U.K., the fragility of the food supply chain, and we would expect that common sense will prevail in relation to some of the challenges that the U.K. are facing from a food supply chain perspective, despite all of the posturing that's going on. So there will be changes to the nature of how we trade in Ireland and in the U.K. as a result of Brexit. But we believe that we have the capability to withstand all of those and to work towards capturing market share, towards being a participant in consolidation both at a supplier level, at a distributor level, and witnessing what goes on at a farm level from a consolidation perspective. In addition to that, there's plenty of regulatory change ongoing with the new EU Farm to Fork Strategy, with new changes to the cap payment schemes within the EU, but all of those are changes that Origin has faced before, and there are changes that we will continue to face for the foreseeable future. But the fundamental nature of farming and the fundamental operations of farming, we don't think will change in any great way. Maybe we'll touch upon sustainability now. And if I could ask Brendan Corcoran maybe to talk us through some of the challenges that are being faced by the organization in relation to sustainability and how we intend to address them.

Thank you, Sean. To set our strategy for the next decade and beyond, we conduct a materiality assessment with input from both internal and external stakeholders, to better understand how Origin can make meaningful contributions to the economy, society and the environment. To ensure optimum impact, we are focusing on 3 strategic pillars, the first of these pillars really looks outside the organization and across the full supply chain to promote and deliver sustainable food production systems. Both Pillar 2 and Pillar 3 are more focused on the actions we take within our own organization, such as responsible business practices through the reduction of carbon emissions, conservation of water and minimization of waste and also commitment to upholding the highest level of ethical standards and health and safety. And also then, as we look to Pillar 3, increasing our level of transparency so that people from the outside can see the actions that we're taking which work and also the areas where we need further improvement as we continue on this journey over the coming years. Action on these goals requires a shift in behavior, investment choices and active engagement with all stakeholders. While equally committed to each pillar, our biggest opportunity to create a beneficial impact is through innovation and our ability to bridge the gap between academic research and practical application on farm. For this reason, we believe our approach is a necessary one. As growers face an increasingly complex environment with greater scrutiny on production techniques, a necessity to transition from older technologies and an urgency and policymakers to achieve climate goals, as evidenced from the European Farm to Fork and biodiversity strategy and also the introduction of the agricultural bill in U.K. To address this need, we have developed a 5-point plan within our agri business to tackle some of the most pressing needs. Collaborating with customers to work towards achieving net 0 food production by 2040 and also leading the adoption of new technologies as we accelerate the path towards a zero emissions economy. Some of the areas in which we practically introduced initiatives include the introduction of sustainability rating for our seed varieties. We see this as a key step as we look to reduce the reliance on traditional crop protection products over time. When we ask growers, which areas have the production system require advice and guidance, improving soil health consistently comes out as their #1 priority. For this reason, we have placed at the top of our list for innovation. And this has been demonstrated over the last decade as we have continued to develop our tailored nutrition products, focusing on maximizing nitrogen use efficiency and ensuring after nutritional balance. Also this year, as Sean mentioned in these earlier slides, we're very proud to announce that we've -- one of the first companies in the U.K. to launch an independently verified carbon calculator, which has been verified by ADAS, which incorporates calculations across our full 13,000 blend of fertilizer. We understand the complexities that the future holds. However, we also believe that there has never been a better opportunity for Origin to help shape the future sustainable food production systems. We also understand that we don't have all the answers. However, our dedicated research and development and the agronomist underground are dedicated to delivering this over the coming years. I'll just hand you back to Sean now.

Thanks, Brendan. So to summarize, well it has been a challenging year for Origin, and you'll be familiar with this slide from our earlier trading updates within the year. Principally, the change in cropping mix, which is in the pie chart at the top of the slide, have driven very significant gross margin mix opportunities downwards over the course of the year. Our winter planted crop is significantly more profitable for Origin than our spring planet crop and obviously, there was a big increase in the Fallow area as a result of the very heavy rainfall in the course of autumn/winter 2019. That mix change has driven a very significant drop in profitability in our Ireland U.K. segment this year. The indications are, and this is a third-party AHDB view on the wheat area that is likely to be planted over the course of '21, '22. And the indications are, at this stage, that the cropping area for our winter wheat will rebound significantly over the course of the next 12 months. However, drilling is only now beginning in relation to winter wheat. So it's too early to be getting very excited about what level of winter wheat may be planted. We're clearly very dependent on the weather outcomes over the next few months and the impact that, that has on planting. But it is our expectation that following what was a 1 in 30 year event from a weather perspective and from a rainfall perspective, is not going to be replicated in the current financial year. That's our view. But again, we're very heavily dependent on what that weather outlook is over the coming months. Apart from that, we're delighted to continue to maintain service through the COVID-19 period. And again, I'd like to pay tribute to all of our staff, who all worked tirelessly in terms of both making their colleagues safe and working well through that period in what are challenging operating conditions. The cash management and the discipline around working capital across all of our business divisions, but particularly Central Europe has been fantastic within the year. There is continued work towards achieving all of the strategic goals, both in the areas of product mix and margin development within the business. The work ongoing in relation to sustainability and how Origin can be at the forefront of addressing some of the environmental challenges that farmers will face over the coming decade. The work ongoing in relation to branding and harmonizing our branding across the group. And small elements of CapEx that will deliver what we believe will be good organic growth within the business over the coming years. We've got a prudent risk management approach and capital allocation strategy currently in focus, and that will remain in place at least until January in advance of the covenant measurement at that point in time. We're not ruling out acquisitions completely for FY '21, but they certainly won't come in the first half of the year. And there are a number of small acquisitions or opportunities that may be available to us in the latter part of FY '21 that we may look to do if the opportunity arises and if the price is right. Brexit will pose a challenge. There's no doubt that it has implications for the Irish agricultural sector and the U.K. agricultural sector. But we do believe that we are well positioned to deal with those challenges. And the ongoing COVID-19 pandemic and in particular, I suppose, the rise in cases and the rise in restrictions in the U.K. may have implications for our amenity business within the U.K. We believe we will be able to continue to operate a full agricultural business in that context, but certainly, demand in the amenity sector may again prove problematic through FY '21. And finally then, the leadership team that we need to have in place to deliver on the group's long term ambitions, I think, is in place. I think with TJ's appointment this year and some of the other appointments that we've already mentioned, we've got an executive team now in place that can deliver on those 2023 strategic growth conditions. Not anticipating any further changes to management team in the short term, but we've built out a good, strong capable management team to deliver on the long-term ambitions for the group. So I'm happy to take any questions. Bear in mind that both Brendan Kent and Alex Steel are also on the call. So happy to take any questions that you may have.

[Operator Instructions] And your first question comes from the line of Jason Molins from Goodbody.

If you don't mind, just generally, sentiment in the U.K. at the moment, it would be useful to hear any comments, given the challenging year for the farmers. Maybe just some comments around yield expectations, given the harvest is all but complete? And then just, I guess, general drying conditions at the moment as they contemplate drilling for the seeds in the head? Second question is really around cash flow. Obviously, an exceptional performance in the second half of the year, mainly driven by working capital being a standard feature. Can you maybe just elaborate a bit further what are some of the key drivers behind that? Was it tighter inventory, payables, et cetera? And how much of that benefit should we expect you to hold on to for this year? And then maybe, as you said, Brendan is on the line. So again sort of hear sort of his thoughts around the third larger business and from where he's sitting, and that's from a supply demand and a pricing perspective. And may be any comments you'd like to make around just the general European policy with regards to that space? There are 3 questions.

Thanks, Jason. I'll address the first 2, and maybe will Brendan come in then. So in terms of U.K. sentiment, obviously, yield is well down and the planted area as well down, so there is quite a significant reduction in terms of the winter wheat yield this year. I would say, though, that despite that, farm sentiment is reasonably good. Pricing has moved upwards, so output prices have strengthened on the back of the weaker yields and the lower planted area. And I would say that drilling, farmers are very keen to get on land and drill possibly too early. So they're bursting out of the traps to try and get planted as early as possible in terms of the winter wheat area. There have been some talk of a winter wheat area of up to 2 million hectares being planted. And while the AHDB slide talked about EUR 1.8 million, there is some chatter that potentially a planted area of up to EUR 2 million is possible. The oilseed rape area, which drilling has concluded on at this stage will be down on the previous year. And that's more to do with the banning of neonics, which occurred this time last year and the prevalence of the cabbage stem flea beetle which has an impact on the oilseed rape crops. So again, farmers switching out of oil seed and potentially into winter wheat. So we're expecting a rebound in the winter wheat planted area, but drilling is only really commencing now. And as we know, winter wheat can be drilled up to the end of January, so there's a long way to go between now and the end of January in terms of drilling, and it's far too early to call. From a cash flow perspective, I would say it's disciplined across all fronts, Jason. So inventory has been reduced in line with the reduction in sales. There's no business carrying an excess of inventory at year-end. There's been good discipline around debt collection and debtor collection right across the geographies, and there's been good work done particularly, E&C in relation to tidying up the debtor book, considerably. Of the EUR 13 million movement, an element of that has been related to the COVID-19 U.K. VAT deferrals, so close to EUR 15 million is as a result of deferral of U.K. VAT, and that will be an outflow in the second half of next year. But we are expecting apart from that outflow, general inflows from the business again in FY '21. And hopefully, we'll be able to match that VAT outflow to leave us in a relatively neutral position year-on-year. Apart from that, there's very consistent working capital performance as the CE businesses. The average working capital across CE was EUR 29 million debtor year-on-year at an average level. And at year-end, it was EUR 18 million debtor. So it was very consistent across the board and well-managed through the year. And a key driver for that is that product mix change and terms change that I mentioned at the outset of the call. So selling less commodity products, whether it's a commodity fertilizer or commodity crop protection product, and selling more specialist fertilizer or specialist crop protection products with higher margins has been one element of it. And the other element of it then is being firm with the CE businesses and they, in turn, being firm with their farming customers around the terms that we will give on product sales. And rather than a mix or a higher mix of credit versus cash sales, which we have seen over the last few years. We've been turning the dial back on those credit sales and moving more towards cash sales where possible. Now that's a slow boat to turn. It has moved by 2 or 3 percentage points year-on-year back in our favor, but can continue to turn back in our favor, we believe. So ongoing work in that regard. Maybe, Brendan, do you want to talk to...

Sorry. What would the split be in terms of cash flow from...

Pardon?

What would the split be, cash versus credit sales generally?

Yes. Within our CE business, it's roughly 25% cash, 75% credit. And then there are varying credit days within that mix, Jason, but that's the rough split in the CE businesses. Okay. Brendan, do you want to touch on fertilizer and the pricing dynamic, supply and demand?

Okay. Jason, a few questions there within your question. First of all, just in relation to pricing. I suppose when you look at the 3-, 4-year cycle on fertilizer, pricing, in general, is probably at the lower end of that scale. Having said that, I suppose, our view for next year is that, on average, fertilizer prices will be similar to what we've experienced this year. With regard to the, I suppose, the EU Green Deal, obviously, there's huge emphasis on the environment. It's not something new to us. I mean, we're operating in an environment where sustainability of practices has always been there. I mean, referencing, when you think back to the water directive back in the early '90s. So our view on that, the Green Deal, is that the emphasis going to be on trying to ensure nutrient waste or loss is kept to a minimum. And for us, that plays into our blending offering where we're developing and continue to develop our own brand of our range fertilizers, which minimizes on losses of nutrient and focuses, particularly on soil and nutrition as opposed to just being fertilizer centric. With regard to the demand, I think we have to take both U.K. and Ireland a little bit separate. Ireland, the demand is driven by life stock numbers, dairy numbers. That's been very, very strong and commodity prices in the dairy area continues to be healthy. So that's a big, big driver for us in terms of the grass crop. In relation to the U.K., we would -- let's about 70% of consumption of fertilizer is driven by cropping area. This year, it has been -- the year is finished. It's been disadvantaged probably to winter cropping. We expect that to recover. And that would create a regular demand for fertilizer.

Great. Thanks, Brendan. I think the overall sense, Jason, is that the likelihood with the new directives on Farm to Fork and the desire to reduce the amount of nitrogen applied will place a greater opportunity on us in terms of the blended fertilizers as Brendan said. There's an opportunity there around our enhanced efficiency fertilizer blends. And as you know, the more complex blend that we can sell, the higher the margin opportunity is within that. So while at an overall level, you may see some reduction in nitrogen usage on farm, and we expect to see reductions in nitrogen usage on farm. We do believe that the complexity of our blending offering and the move to stronger brands and stronger offerings within the fertilizer segment can at least replace any of that volume shift downwards within the nitrogen market.