Quantum Foods Holdings Ltd (QFH) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. And welcome to the results presentation of Quantum Foods for the 6 months that ended on March 31, 2020. It's an extraordinary time in which we live. So it's the first time that we're doing the presentation in this format. Our agenda follows a normal rhythm. I will give an overview of the business. And then our CFO, André Muller, will handle the finances. I will then be back talking about the operations and the outlook for the business. And then there are some appendixes, which you can study in your own time. We then start with the business overview. Headline earnings per share decreased due to a continued downturn of the egg industry. Although our revenue was up by 16%, the operating profit declined by 25% and HEPS declined by 24%. This decline is all in the margin in the egg business. And we will give more detail about that a bit later. The cash generated was ZAR 62 million, which is precisely the same number than it was last year this time. And that was pleasing for us because in the previous year, we had significant improved results. We decided to declare an interim dividend of ZAR 0.06. And the Board was of the view that the strength of the balance sheet, the available cash on the balance sheet is sufficient that we are able to declare this dividend. We also have a credit facility, should we require that. The dividend is however ZAR 0.02 less than it was last year. The environment in which these results were achieved were as follow. Firstly, we had higher raw material prices. SAFEX yellow maize prices increased by just over 5%. Bran and hominy chop prices also increased, but the landed soybean meal prices declined. The rand also weakened by 6.2%. If we look at the raw material prices as a whole, this had the effect that our feed prices increased by approximately 4%. The second big factor that impacted on the business was the lower egg prices. Egg prices declined in excess of 7%. And that is driven by a larger layer flock. South African layer flock was estimated to be 28.1 million at the end of September, our year-end. And at the end of March this year, it increased to an estimated 29.4 million. The third relevant factor in the business is the outbreak of COVID-19 at the end of March 2020. But that had minimal impact on the business results as we present them today. I will now ask André to talk through the financial results of the business. Thank you.

Good morning, ladies and gentlemen. Group revenue increased by 16% to just over ZAR 2.4 billion. This increase mostly from the feed segment due to higher volumes sold. Operating profit, that includes the profit and loss on sale of assets, decreased by 24% to ZAR 91.4 million. The feeds and farming businesses improved profitability and the other Africa segment reported lower earnings. The main reason, however, for the decline in earnings is the further decrease in profitability in the egg business, which recorded a loss for the period under review. Both operating profit and finance costs were impacted by the introduction of IFRS 16, the new lease standard in the current reporting period. Operating profit was higher by ZAR 4.5 million and finance costs also higher by ZAR 3.8 million due to the standard. Including the IFRS 16 interest charge, finance costs for the period amounted to just below ZAR 1 million. The effective tax rate was 27.5%, resulting in a profit after tax of ZAR 66.6 million for the 6 months to March 31, 2020, which amounts to a decline of 30%. Adjusted operating profit, that's operating profit excluding the profit or loss on sale of assets, decreased by 25% to ZAR 91.3 million at a margin of 3.7% compared to the 5.8% achieved in the previous year. Headline earnings per share decreased by 24% to ZAR 0.345, the headline earnings per share number benefiting from a further repurchase of shares in the second half of 2019 and the first half of 2020. The Board intends to continue with the repurchase of shares. Turning to the segmental analysis of revenue. Revenue from animal feeds increased by 38% with an increase in average selling prices, which was adjusted in response to higher input costs and an increase in volumes sold. Included in the increase in volumes sold is the effect of a change to the broiler farming business model in the North, where previously fully grown live broilers were sold in terms of a long-term supply agreement. This agreement was amended in 2019 and now provides for a sale of day-old chicks and feed with the contracted party rearing the day-old chicks to maturity. This resulted in a decline in revenue for the farming segment and an increase in revenue for the feed segment. Revenue from feeds contributed 44% to group revenue for the first 6 months of 2020. Revenue from eggs increased by 8% and remained approximately 25% of total group revenue. Volumes sold increased by 16.3%, but average selling prices declined by 7.4%. The decline in farming revenue include the change in business model highlighted earlier, higher volumes of live broilers supplied and the risk with that, and a slight increase in the revenue from layer livestock. Farming contributed 27% of total group revenue for the period, down from 32% in the comparative period. The revenue from other African operations was higher with increased revenue in all 3 countries. The revenue contribution from Africa remained at just over 5%. Adjusted operating profit, that excludes profits and losses on the sale of assets, is reflected on this slide. Eggs reported a loss of ZAR 19.5 million for the period. The change in profitability is due to the combined effect of higher production costs and lower selling prices. This decline in gross margin per dozen exceeded the benefit of the increase in volumes sold. Overhead costs were well managed, and with the improvement in volumes, lower on a per unit basis than in the previous year. Farming profits improved by ZAR 16 million, benefiting from higher volumes sold and improved efficiencies on the commercial layer farms. Layer livestock volumes increased but profitability reduced, following lower demand from external customers for point-of-lay hens and cost increases ahead of target being incurred in this business. Animal feeds profitability increased by ZAR 8 million, supported by volume growth of both sales to the external market and increased internal demand from the layer farming business, where bird numbers were higher than the previous year. Profits from other African countries declined in Uganda and Zambia but was higher in Mozambique. The eggs businesses in these countries performed relatively well. However, the breeder businesses were negatively impacted by lower demand for livestock. This next slide provides an overview of the impact of IFRS 16 on the financial statements for the first half of 2020. The comparative numbers were not adjusted with the effect of IFRS 16 accounted for on 1st of October 2019. On that date, the following adjustments were made to the statement of financial position, an increase in assets of ZAR 62 million, an increase in liabilities of ZAR 72 million and a decrease in retained income of ZAR 10 million. The leases accounted for comprised mainly the outsourced distribution arrangements of the group and the rental of egg-packing facilities in Pinetown and Bloemfontein. For the 6 months to end March, operating profit increased by ZAR 4.5 million and headline earnings per share were ZAR 0.2 per share higher due to the application of the standard. Turning to the statement of financial position. Noncurrent assets increased by ZAR 78 million compared to September 30, 2019. This include IFRS 16 right-of-use assets of ZAR 60 million and capital expenditure of ZAR 55 million. Net working capital increased by ZAR 65 million with increased investment in poultry stock and a higher investment in accounts receivable. Noncurrent liabilities mostly reflect the deferred tax liability of the group and increased by ZAR 10 million, mainly due to increased deferred tax liability for the higher poultry stock investment. Cash amounted to ZAR 174 million at the end of March and included the benefit of maize's hedging positions being in the money at 31st of March and some earlier payments received from customers. Borrowings of ZAR 74.2 million is all related to the IFRS 16 lease liabilities. Total equity increased slightly and amounted to [ ZAR 930 ] per share at the 31st of March. Turning to the statement of cash flow. Cash operating profit of ZAR 145 million was recorded for the period while the working capital investment increased by ZAR 73 million. SAFEX hedges resulted in a cash inflow of ZAR 14 million. Finance costs and cash outflow from principal lease payments include the IFRS 16 adjustments. After paying tax, cash generated by operations amounted to ZAR 62 million for the period. ZAR 48 million was spent on the final dividend of 2019; ZAR 4 million on purchasing shares held in treasury; and ZAR 55 million on capital expenditure, the net cash decrease being ZAR 45 million for this period. Capital expenditure for 2020 as well as future capital expenditure approved by 31st of March is indicated on this slide. Of the ZAR 55 million spent in the period, ZAR 35 million was spent in South Africa and ZAR 20 million was spent in the rest of Africa. The main items in addition to maintenance and compliance CapEx being: expansion of the Uganda breeder business and an egg grader for the East London packing station. Future capital expenditure approved by 31st of March amounts to ZAR 86 million and consists mainly of maintenance and compliance CapEx, efficiency improvement at the Malmesbury feed mill and the completion of the expansion project in Uganda. The impact of COVID-19 on the business will be taken into account in the further execution of approved capital expenditure. Hendrik will now present the operational review.

Thank you, André. As usual, I shall start off with Nova Feeds. In the past couple of years, we've spent capital in this business to expand the business. And at this stage, I think we can say that these expansions were successful. We've seen volumes increase by a further 18% in this period. And with that, margins also improved. We are quite satisfied with the way that this business has performed, and we are running at optimal levels compared to the installed capacity. The load shedding had a negative financial impact on 2 levels: firstly, the feed that had to be bought out at a higher cost than that we would produce it; and then furthermore, the negative effect on overhead recovery. Cost per unit were well managed and remained under control. Part of the success in this business is really the product performance. And we invest a lot of money in R&D and we work well with our international partners. We also measure the product performance on our customers' farms on a monthly basis. And the performance remain at a very high level. If we move over to layer farming. The last 3 years is all about improving the productivity on our layer farms. And that improvement is still continuing. Our breeder performance has been stable for some time now, and it remains above Lohmann standards. Production of day-old pullets and point-of-lay hens increased. Day-old pullet sales, however, decreased as we placed more of these pullets on our own rearing farms. And you would see that the point-of-lay sales increased and then the flock on our own farms also -- commercial farms increased. Commercial rearing performance was above target. I think the most pleasing aspect of the 6 months' performance that we've seen is that our commercial layer performance is now at acceptable levels, both from a productivity perspective and also a financial perspective. It's been a long and tough road, but the farms are all performing up to our expectations. The one black mark against this business segment is the cost increases in the breeder business, which we could not recover in the market. And that is something that we have put systems in place to address. In the commercial layer business, however, costs were well managed and cost per dozen, in fact, decreased. Just to note that we've seen a decline in layer livestock demand from February 2020. Hopefully, we will see a smaller South African layer flock going forward, which could be beneficial for egg prices in the next period. The broiler farming again produced the pleasing financial performance. This business has really, for the last couple of years, produced stellar results in spite of our breeder performance that went negative for a while. That is now slowly improving. We'll not see the completed flock numbers improving this year. But our daily and monthly performance certainly shows that we've turned the corner in our breeder performance. Hatchability also improved but is not yet at acceptable levels. Broiler performance in the commercial broilers at a very high level. And it is quite clear that the debit that we're taking in the breeder performance is certainly being compensated for a good broiler performance on the genetics. Overhead costs were well managed, both day-old chick cost and live broiler costs, overhead cost decreased. And then we have invested in our hatchery capacity 2 years ago. And we've slowly been growing that business. And also in the hatchery, we are reaching optimal capacity and the production of the day-old chicks for the group increased by 4.1%. Nulaid Eggs. I think this is the big swing factor in the business. And clearly, supply and demand was not in balance in the past 6 months. Egg prices decreased by 7.4%, but our volumes increased by 16%. The volume increase could not make up for the effect of the decrease in prices. And the margin destruction was exacerbated by the feed cost that increased. If one looks at the combined effect of egg decrease and gross -- and cost of sale increase, that impact is in excess of ZAR 60 million. And you would have seen the decline in the egg segment is less than that, which is testament to the effect of the higher volumes and then the operational efficiency, which remained at very high levels. Now we were concerned, with the bigger volumes, that operational efficiencies might suffer. But I think the egg business team has done exceptionally well. Even now post March 31 with the impact of COVID-19 and all the arrangements there to be made, operational efficiencies are still very strong and the business is well managed. Our overhead cost on a rand per dozen basis was also lower. This is also testament to the well management of the business. We do see initial indications that demand for eggs is improving. And certainly, we also think that going forward, there will be a lower supply. And that should support pricing. The other Africa segment, 6 months ago in November, we reported that the industry conditions were difficult, well, they remain difficult in all 3 countries. Raw material prices increased. And as explained previously, just to remind you that the impact of that is that the small-scale farmers don't buy day-old chicks or day-old pullets because they can't feed them due to the high raw material prices. And that means we don't have demand for our product. In Zambia, for example, we had record maize prices in excess of ZMW 5,000 per tonne coming from a kwacha level of ZMW 1,800 per tonne in the prior year. So that's had a devastating impact on the cost of the business. The kwacha currently -- to give context, currently about 1:1 on the rand. In Zambia, we also scored some own goals with a decline in productivity levels, particularly at the breeder farm. And we're in the process of addressing that. Uganda, the breeder farm is ready for placement. It was ready for placement at the end of March. And in fact, the first Lohmann Breeders are on that farm already. That project has been a bit delayed due to COVID-19. But we will -- as soon as that is over, we are very confident that we would see the production and financial benefits of that project. Then Mozambique performed very well in the current conditions. We were concerned about Mozambique in the beginning of the year. And it was really a pleasant surprise to see how well that business performed, improvements in productivity and certainly improvements in egg pricing and the mix, distribution and channel mix in which we sell. Although the Africa finances does not make pretty a reading, it is important to note that there's been a positive contribution to the bottom line of all 3 countries. All 3 countries are well capitalized. They have cash in the bank. And we do not foresee that it would be necessary to support that country from an operational cash injection perspective. If we turn to the outlook, now in an agricultural company, outlook is always difficult because you're dependent on the weather and you're dependent on the government and you're dependent on the exchange rate. And this year, we've got COVID-19. So any forward view is dangerous. And I can, with a clear conscience, say I don't have a good view of what's going to happen financially in the next 6 months. But I will try to give you our best view. We believe that raw material prices would increase. But that is just due to the exchange rate. We have a maize harvest which is anticipated to be above 15 million tonne. It is a massive maize harvest. But the export parity remains high, and we're not seeing the benefit in the maize price. And that will flow through -- that effect of a weak rand will flow through to the consumer. The egg price direction is certainly, for us, we do not know. On the one hand, there has been increased demand due to people baking more. There has been less eggs flowing to the market due to the fact that people have culled -- producers have culled many hens in January and February. And there has been, initially it seems, down placements of day-old pullets. So we believe there are reason for egg prices to increase. Of course, we're very aware of the fact that there's COVID-19, and we have to find a balance between having a sustainable business because we can't continue trading at loss-making situations or just at the position where we do not make enough profit to reinvest. But we also are very aware that we cannot abuse the situation to the detriment of consumers. Our feed and broiler livestock volumes should stabilize, certainly do not see another 18% increase in feed volumes. I think the volumes has been good. It would now be a focus on efficiency and making sure we sell to the right customers at the right price. I've stated about the demand for layer livestock. And I think that should decrease. Then lastly, the Zambian business should start improving. The Zambian business has had a torrid time, torrid 18 months. And certainly, if one clearly looks at the economy there, it seems that there's more maize, there's been more rain, electricity supply is improving. We believe that the agricultural economy is improving. And therefore, our business should also start improving in the next 6 months. Thank you very much. Well, we've received no questions. So we cannot engage with you with regards to a Q&A session. I would, however, like to use the opportunity to thank one of our team members who is retiring at the end of July. Jimmy Murray has been with us a number of years. And Jimmy has played an incredible positive role in our business. He has technical and scientific insights into poultry and egg farming, which is second to none. He has also been able to operationalize those insights and help us achieve far better performances. If I look at where our farming operations, both in broilers and layers, were when Jimmy joined us and where they are now, it's really testimony to the efforts he's put in on many levels. Jimmy was also, and I'm sure, will continue to be a mentor for many of our farmers in the group. He was always able to engage with people, listen to them and give advice. And he was not shy ask advice if he didn't know. So Jimmy, thank you very much. And on a personal level, you played an extremely positive role in my career and in teaching me a lot about how to manage a farming business. After Jimmy retires, he will be taking a couple of months off as a well-deserved rest. And then he will come back full time to the company. He will be working full time for us in a different role, and specifically a role to utilize some of the opportunities that we have and assist us with some of the challenges that we have. It would not be on an executive level, but he would be available to assist us. So Jimmy, thank you. And I trust that you and [ Jenny ] and your family will enjoy your couple of months off. Thank you, everybody, for listening to our webcast. We sincerely appreciate your interest in our business. And our shareholders can be assured that we are positive, and we will definitely prevail in these difficult circumstances. And when circumstances improve, I'm sure the business will go from strength-to-strength. Thank you very much.