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 year ended September 30, 2020. My name is Hendrik Lourens, and I'm the CEO of Quantum Foods; and André Muller, who is our CFO, will be doing the results presentation with me. You would be able to ask questions through a chat box, which you just open the questions box and then submit your questions. At the end of the presentation, André will read all the questions. And between him and I, we shall try and answer these questions. Our whole executive team is with us here. You can't see us obviously, but if there are any questions that we don't know the answers, they will most certainly be able to shed some light on that. Our agenda follows the normal flow where I shall start off with a business overview, André will then present the detailed financials. I will then discuss the various operations and end off with how we see the coming year and what our focus is -- will be. In the past year, we saw a revenue increase of 15%. And André will unpack the revenue increases, but it's mostly due to increases in our feed business, driven by raw material increases. Operating profit and headline earnings per share declined by 10% and 13%, respectively. And our total dividend was ZAR 0.16. We declared a final dividend of ZAR 0.10 and the interim dividend of ZAR 0.06, which gives a total dividend of ZAR 0.16. As you are aware, our aim is to have a dividend cover of 4, and this dividend cover is closer to 5. The various reasons for that: Firstly, we expect working capital investment to increase substantially in the next couple of months due to raw material price increases, which are already with us; secondly, in the egg cycle, we expect the egg margin to close drastically, which would mean that we would be generating less cash from that business; thirdly, we have some capital requirements and commitments that we've made that we need to complete; and then lastly, the uncertainty around COVID and the impact of that on the consumers' ability to buy and also the impact on our business is something that we're concerned about, and we don't really have a total grip on what's going to happen with COVID. And we thought it prudent to be more conservative. You would see that the cash that was generated by operations is ZAR 209 million compared to the ZAR 178 million of last year. We invested less in working capital this year than last year, but André will also share those details. So in summary, the Board believed that it was a solid performance in fairly volatile industry conditions. The COVID-19 had no material negative impact on our business. Later in the presentation, I will talk more about the COVID impact. Our margin closed due to raw material cost increases across the board, maize, soya, driven mostly by rand weakness. And you would see in the end of the presentation, there are addendums where it is quite clear what the increases were from -- in these commodities. There's been some corporate action during the year. Country Bird Holdings purchased the share of Zeder Investments. And Artistotle Africa, a Luxembourg-based investment fund, purchased the shares of many of our institutional shareholders. And Aristotle Africa is now the biggest shareholder in Quantum Foods and Country Bird Holdings, the second biggest. We are pleased that our defensive portfolio remained resilient in the last year, and we believe it will remain resilient in the year to come. André will now do the financial overview.

Good morning, ladies and gentlemen, and welcome to the financial overview section of the results presentation. The group revenue increased by 15% to just short of ZAR 5.1 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 11% to ZAR 218.5 million. The feeds and farming businesses improved profitability and the Africa segment reported lower earnings. The main reason, however, for the decline in earnings is the decrease in profitability in the egg business, which show increased cost of production and lower selling prices. 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 8.8 million, and finance costs also higher by ZAR 7.7 million due to the standard. Including the ZAR 7.7 million interest charge, finance costs for the period amounted to ZAR 2.6 million. The effective tax rate was 28.1%, resulting in a profit after tax of just short of ZAR 155 million for the full financial year, down from ZAR 189 million in 2019. Adjusted operating profit, that is operating profit excluding any profit or loss on sale of assets, decreased by 10% to ZAR 219.6 million at a margin of 4.3% compared to the 5.5% achieved in the previous year. Headline earnings per share decreased by 13% to ZAR 0.805. The HEPS number benefiting from a repurchase of shares in the second half of 2019 and the first half of 2020. Turning to the segmental analysis of revenue. Revenue from animal feeds increased by 27%, with an increase in average selling prices, which was adjusted in response to higher input costs and an increase of 20% 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 implemented from May of the previous financial year, which resulted in a revenue shift from the farming segment to the feed segment. On a like-for-like basis, volumes increased by 13%. Revenue from Feeds contributed 44% to group revenue for the 2020 financial year. Revenue from Eggs increased by 12% and remained approximately 1/4 of total group revenue. Volume sold increased by 15.4%, but average selling prices declined by 2.4%. The increase in farming revenue came from higher volumes of point-of-lay hens sold to egg producers and higher volumes of broiler live birds sold to our customers in the Western Cape, offsetting the reduction in revenue following the change in business model highlighted earlier. Farming contributed 27% of total group revenue for the period, down from 30% in the comparative period. Revenue from Other African operations was higher, with increased revenue in all 3 countries due to higher volumes of eggs sold. The revenue contribution from Africa remained at just over 5%. Segment results. Adjusted operating profit, again, operating profit that excludes profit and loss on the sale of assets is reflected. Eggs reported a profit of ZAR 6.3 million for the period. The 6 months to 31 March loss of ZAR 19.5 million was reversed to achieve a profit for the full year, with profitability in the second half benefiting from an increased demand for eggs following the introduction of COVID-19 lockdown regulations. The change in profitability for the full year is due to the combined effect of higher production costs and lower selling prices, which was partially offset by the higher volumes, a decline in overhead cost per unit and very good operational efficiencies. Farming profits improved by just over 8% to ZAR 121.5 million and contributed more than 50% to the group operating profit. Positives were the improvement in efficiencies under commercial layer farms and the higher volumes of live broilers sold in the Western Cape, while achieving a high level of efficiency. Layer livestock volumes increased, but profitability reduced following lower demand from external customers for point-of-layings, resulting in slower depopulation in the first half of the year. This resulted in feed and overhead costs ahead of target being incurred in that period. Animal feeds profitability increased by 11% to just short of ZAR 100 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. Operating costs were well managed and was lower on a per ton basis than the previous year. Profits from Other African countries declined in Uganda and Zambia, but was higher in Mozambique. The egg businesses in all 3 countries performed better than the previous year. The breeder businesses in both Zambia and Uganda were, however, negatively affected by lower demand for livestock due to both higher feed prices and the lockdown restrictions imposed in these countries. Turning to the statement of financial position. Noncurrent assets increased by ZAR 41 million compared to September 2019. This increase includes the IFRS 16 right-of-use assets of ZAR 58 million. Capital expenditure for the period was ZAR 91 million and depreciation charge ZAR 74 million, and lower and values of assets from the African subsidiaries due to especially the Zambia kwacha weakening against the rand. Net working capital increased by ZAR 20 million. Accounts receivable balances increased due to increased revenue, while accounts payable and poultry stock balances were lower than the previous year. Non-current liabilities mostly reflect the deferred tax liability of the group and decreased by ZAR 20 million, mainly due to the decreased deferred tax liability from the lower poultry stock investment. Cash amounted to ZAR 251.8 million at the end of September, an improvement of ZAR 32 million from September 2019. Borrowings of ZAR 72 million are all related to the lease liabilities from IFRS 16. Total equity increased slightly and amounted to ZAR [ 9.42 ] per share at year-end. Turning to the statement of cash flow. Cash operating profit of ZAR 332.5 million was recorded for the period, while the working capital investment increased by ZAR 70 million. The rand value of cash balances held in foreign currencies decreased by ZAR 4 million due to exchange rate movements, whilst FX hedges resulted in cash inflow of EUR 3 million. After finance costs and paying tax, cash generated by operations amounted to ZAR 209.5 million for the year. ZAR 60 million was spent on the final dividend of 2019 and the interim dividend of 2020, ZAR 4 million on purchasing shares held in treasury and ZAR 91 million on capital expenditure. The capital portion of lease payments amounted to ZAR 22.4 million. This, in essence, a reallocation with the corresponding cash outflow for 2019 included in the cash operating profit as an operating expense. Capital expenditure for 2020 as well as future capital expenditure approved by September 30 is indicated on this slide. Of the ZAR 91 million spent in the period, ZAR 67 million was spent in South Africa and ZAR 24 million in the rest of Africa. The main items in addition to maintenance and compliance CapEx being expansion of the Uganda breeder business, capacity expansion at the Malmesbury and [ George ] feed mills generated for the Paterson feed mill and an egg grader for the East London packing station. Future capital expenditure approved by September 30 amounts to ZAR 162.5 million and includes the acquisition of a broiler farm that is currently supplying the group with birds in the Western Cape, further expansion of the Uganda breeder business, increased capacity at the layer farm in [ halting ] and the maintenance and compliance CapEx. The impact on operating profit in the egg business caused by changes in key profit drivers, assuming all other factors remain constant, is indicated on this slide. A change of 1% in egg selling prices, just about ZAR 0.0125 per egg, will change annual operating profit by ZAR 12.6 million. The change of ZAR 100 per tonne in the cost of maize would impact operating profit by close to ZAR 9 million and a change of ZAR 100 per tonne in the cost of soy meal will impact operating profit by about ZAR 2.6 million. I thank you for your attention. I will now hand over to Hendrik for the operational review.

Thank you, Andre. It's a very nice picture of 1 of our broiler farms in the Western Cape. I'll start off with an Nova Feeds. The highlight of the Nova Feeds performance was the excellent growth that was achieved through the year. Volume grew by 13% and in the last 5 years, Nova Feeds has really gone from to strength to strength especially if you compare it against the growth of the industry, and we have certainly taken market share from a number of competitors. But not only did our volumes grow, we improved the rand per tonne margin due to changes in product mix. It's not often that you see in a business of this nature, volume and margin growth. And the combination of this translated into a good profit performance by Thinus and his team. The cost per unit declined due to diligent cost management, but also increased volumes. Obviously, the volume increased at a very, very positive effect on this measurement. Load shedding remains a challenge and cost us about ZAR 3.5 million for this year. The Board has approved capital to ensure that we mitigate the load shedding that we believe still lies ahead for us. And it is very pleasing to report that the investments at Pretoria and Paterson plants both achieved the financial hurdles. Whenever we do these projects, there's always an element of uncertainty, whether your assumptions will hold true and whether the market will allow you certain prices and whether the input costs are in line. But in both these investments, the management of those areas did very well. We believe that the key to the success in the Feed business lies in the product performance. Farm animals performed well when they use our feed and that's supported by very strong technical and sales team that delivers these products onto our customers. Our layer farming business, that goes under the Bergvlei name, we recorded a record commercial layer performance, and I'll talk about that a bit later on the slide. But to start off with our breeder performances. For many years now, the performance continues to be at a very high level, beating international standards. Our point-of-lay business suffered this year due to challenging industry conditions. What actually happened was that when egg prices started declining, many of our customers either canceled orders or delayed taking point-of-lay birds from our rearing farms. The effect of that was that the point-of-lays remained on the farms longer and consumed more feed. That is for our account. That is not something that we could pass on to the customers. There was also additional costs due to higher placements of day-old pullets, which were reared in the point-of-lay birds. The hatchery investment we made at our [ Bronco ] hatchery, close to [ Bronco Strait ], also achieved the financial hurdles. We increased capacity and managed to sell that capacity in the first 2 years of the capital spend. Then the highlight of the year was our commercial layer performance. You would see, attached is a graph that shows the layer productivity index. That's an internal index that we've developed. You can see that 4 years ago, we really were struggling with our layers. We changed the way that we rear them. We changed the way we feed them, and we changed the feed formulations, and it had a positive effect on the layer flock. And we are very, very pleased with the performance of our commercial layers and also showing that the genetics that we use is very well suited for our conditions. Cost increases were a mixed bag, where in the breeding business, we could not contain our costs, and they increased above inflation, but the cost per dozen eggs produced on the layer farms declined. As with feed, it was assisted by increase in volumes, but Amos and his team also did very well in containing the nominal costs on farm level. Our broiler farming business showed an improved financial performance. Day-old chicks increased by 3.7%. We had good cost management throughout the value chain, per unit cost decreased in both day-old chicks and live broilers. Lacton and his team did a good job there, ensuring that we are very efficient on broiler level. Our breeder performance remain disappointing. Particularly disappointing was that the progress we made last year could not be sustained, and we are in the process of reviewing all sources of hatching eggs. As I stated, the broiler performance improved from an already high level, and there's a clear trade-off in the genetics between our broilers and breeders. Our Hartbeespoort hatchery performance did not meet the investment hurdles, although there was an increase in day-old chick production. We were not efficient. This was not a good performance by us. And what we are doing is we've already changed the management structure, and we will be changing management itself. We're really in the process of doing that and getting new people to ensure that this hatchery operates at optimum levels. Hartbeespoort hatchery is key to our growth plans, and we need to get it right. Then Nulaid Eggs. Again, a very strong operational performance. Sales volumes increased by 15.4%. We are now selling over 1 billion eggs in South Africa. One of the analysts that follows us, Anthony Clark, did a calculation and our CFO checked it this morning, but we sell about 38 eggs per second. So in the 20 minutes that this presentation has been going on, we've sold between 40,000 and 50,000 eggs. The egg prices, however, declined by 2.4% and this is a business where volume is not everything. Margins are important, and prices are very important. The price decline is due to the natural cycle. We've -- layer numbers increased in April 2020, peaked at ZAR 29.5 million. It slowly came back to ZAR 28.6 million, which is significant. But before AI, we had a flock size in South Africa of about 24 million. And we believe that 24 million to 25 million is a balanced flock where supply and demand is well balanced. Now that egg price decline, Andre showed the -- how that affects the bottom line, the sensitivities. The egg price decline in combination with our feed cost increase had a effect of a margin compression of about ZAR 60 million for the year. You would see in the segmental report that our profits decreased with much less than ZAR 60 million, which is testimony to the very efficient business that Adel and her team is managing. Our operational indicators remained at a very, very high level. And I sincerely believe that in terms of running pack stations, we are world-class. I will now like to turn to COVID-19 now. We saw a rapid decline in egg prices from December last year and up to March in this calendar year. However, when COVID broke and we had the lockdown, the hard lock down in particular, that had an extremely positive effect on egg consumption. People stayed at home, started baking, did not go out, they ate at home. And the drop in egg prices was stabilized, and therefore, egg prices for the year only declined by 2.4%. So we can't complain about the negative impact. We do hope that some of the consumer behavior has had a permanent change that people have rediscovered the joys of baking cakes and bread and pastry and that they will continue using eggs. Lastly, the cost per dozen also declined as with the other businesses, good cost management and a combination of that and higher volumes. The rest of Africa, we've seen adverse industry conditions in mostly Zambia and Uganda, also in Mozambique, but particularly Zambia and Uganda. And we've seen it now for the last 18 months. It's not only the last year. We had high commodity prices due to the drought, which had 2 impacts on our businesses, our breeding businesses. Firstly, negative impact on margins, where our cost of sales increased a lot and then also a negative impact on day-old chick demand, where the -- our customers cannot afford to feed the day-old chicks due to the high maize prices, high soybean meal prices, and therefore, the demand for day-old chicks fall away. The drought also has a negative impact on agricultural in general. Sentiment goes negative. There's less cash going around there's fear and people don't want to buy, and they hold their maze or their cash. Then in Zambia, in particular, the weakening of the quarter had severe cost impact we import many of our materials that we use in Zambia and some of our salaries are also fixed in rand or dollars. But the revenue that we get in that country is 95% in kwacha. Egg volumes between Uganda, Zambia and Mozambique increased by 15.7%. We sell just under 200 million eggs per annum in these 3 jurisdictions. I spoke about the volume decline in the breeder business, so I'm not going to repeat that. Our current CapEx cycle, those CapEx that we spoke about last year is now close to completion. We have some new projects in the pipeline, not to the scale of the ones we've had in the past 24 months, but we are still very bullish about Africa, and we're not going to stop investments in specifically a place like Uganda. Lastly, I think that one can say that despite the external challenges, all 3 countries remained profitable and cash generative. It was not necessary for us to support these countries from South Africa. All of them generated more cash than they consumed and have healthy cash balances. And we are actually very proud of the performance of the local management in these countries. If I can then turn to the outlook and then our response to these expectations. The high commodity prices in South Africa into 2021, that's our financial year 2021. That's not an expectation anymore. That's factual. Some of those high commodity prices are not only in our silos, but they're on our farm already. And you can look at the -- or I invite you to look at the graphs at the addendums and you will see that soybean meal and also maize increased rapidly towards the end of the previous financial year. Our response to that is to continue our detailed focus on procurement. We have an absolute disciplined detailed focus. We don't play around with many instruments. We are very conservative. We don't try and beat the market. We try to stay in the market. And that still is in good state in the past. Our concern that as the economy opened up, egg prices will decline further driven by the big supply in the market. For us, the important thing would be to maintain our egg volume base and maybe even grow it if we get the opportunity and then to sell into the most profitable channels. We are fortunate that we sell in all the channels from the most formal channel to the most informal channel, and we are geographically well fit outside South Africa to make sure that if there are opportunities, we can utilize them. We believe the broiler industry will give us growth opportunities in the next 12 to 24 months, and we intend increasing our broiler hatchery capacity in the next 24 months. Obviously, we need to make sure that the current assets that we have are utilized efficiently. We're also optimistic that outside South Africa, the business should benefit from lower commodity prices. And we hope to see the recent investments being maximized and those assets being sweated. The concern of us, and I spoke about it right in the beginning when I spoke about the dividend, is what will happen to the consumer. We have huge unemployment in South Africa. Some of the grants that government gave out during COVID will cease in the near future. And consumers' ability to purchase animal protein will remain under pressure. Our response to that is really to produce products as cost effectively as possible. The other option is to diversify outside animal protein, and we've had many questions about that. And we do not intend doing that. We intend sticking to what we do. We are, we believe, diversified enough as the business is. Then the continued, and I would say, heightened Avian influenza risk. We have seen in Europe in this current winter of them, a heightened incidence of AI and many incidents. In the previous time, we saw this level of incidence, the following South African winter, we experienced AI. There is not much one can do. You can't build a wall and to keep AI out, you can maintain high biosecurity standards and try and even improve that. But I think it must be noted that with the best biosecurity standards, you may still get AI. If you don't have good biosecurity standards, the chances that you get the AI is very good. But it's not a given that you won't get it. It is really -- there's a matter of luck involved. We are well placed due to our geographic diversification, but this is a worry for the whole industry in South Africa. Thank you very much. And hopefully, there are a couple of questions. I'll ask André to have a look and then maybe give a little bit of time if there aren't yet, and then we'll take them. Thank you.

I mean, we do have some questions in the chat room. Thank you for submitting them. Let me start off. This is the first question. Just to ask a little bit more explanation on what is meant by us having a defensive portfolio?

Thank you, André. Well, we -- when we unbundled, we came out of a couple of years of loss-making due to the volatility in the egg business and the broiler business. We -- and our feed business was pretty small. We then decided to invest in the feed business to make the external part of our feed business bigger because the feed business gives us stability. As raw material prices increases, the fact that your raw material price is such a big portion of your selling price has the impact that the whole market increased their prices over time. So you have the ability in the feed business to increase your prices in line with raw material price increases. And in the broiler business, we closed our [indiscernible] and closed 1 [indiscernible] was sold 2 [indiscernible] and entered into contract managing with some big customers. And in those contracts, we have a cost-plus basis. In other words, as long as we farm efficiently and our raw materials that we buy is in line with the market, we get a margin. So we are not exposed to the upside of the broiler meat market, but we are also not exposed to the downside of the broiler meat market. And that's a defensive portfolio. So you never shoot the lights out, but if you farm decently and you buy decently, you're not going to make losses. That left us with the egg business, which is not defensive. There's a lot of cyclicality in it. But I think what we did to make it defensive is we've improved our efficiencies on our layer farming a lot. You can see in the graph and then I've spoken about the pack stations. What was a surprise to us is when we unbundled, our Africa business was far more stable than it is now. We've had a couple of years where it was boom or bust, and we're working on getting sufficient size in the egg business in our African businesses to ensure that it is more stable than we've had in the last. So generally, we were very cyclical, very exposed to cycles. I would say, at least 2/3 of our business now is far less exposed to cycles, and that's what we mean by a defensive portfolio.

The next question we have is, it relates to the performance at the broiler-breeder level and to expand more on the reasons for the poor performance in the last couple of years.

I think we've at previous presentations to shareholders. We were quite open about it, that we are struggling with the core breed. But I think it's not only the breed. We've also made some errors, not react -- we did not react quick enough to the changes in the breed. But we are struggling where we were in the top 25%. We're now probably in the top 30% of our area of responsibility, which is Africa, Middle East, Europe. So we can do better with the current breed, but I think it's not -- I think it is acknowledged that there is a problem with the breed.

The next question relates to the agreement with Astral. And depending -- based on the fact that Astral is now also a shareholder and to comment on the duration of the agreement and whether there will be any renegotiation of the terms of the agreement.

The initial agreement has been extended. So it's much longer now. But there will certainly be no -- there's no intention from our side and we haven't received any intention from their side to renegotiate the agreement.

We've got a question on the impact of COVID on production, give a bit more detail on the number of COVID cases, and if there were any deaths among staff.

Yes. We were -- thank you for that. We were quite fortunate. We've only had 35 positive COVID cases. We had no COVID related fatalities and 35 out of about 2,000 people is quite a small number. I need to say, I think we were very fortunate that on the farming side, it's people is, by the nature of the business, their social distancing. Our risk was really in the packing stations, and there were a lot of mitigating factors implemented in the packing stations. Even the feed mills, you have various floors. So there's also ample opportunity for social distancing. So the nature of the business assisted us to have the fairly low number.

The next question relates to the increase in your office costs and also technical services provided by nonemployees, which have increased year-on-year. And the question is, what are these costs about? And why have they increased? And maybe I can answer that. The cost were incurred in corporate advisory fees. It was announced to the market in a sense that we have -- the Board has elected to appoint corporate advisers during the period of corporate activity. Next question relates to the hedging of major input costs, maize and soya, and to give more idea of how much of our input costs are hedged in terms of our policy.

We -- in terms of maize, we follow a very conservative approach. We are generally between 3 and 4 months long. If we're short, we're 3 months. If we're long, we're 4 months. There are times when for the Nulaid business, we would say this is a very good maize position, and we would go to the Board and ask permission to go longer than 6 months. But generally, we're between 3 and 4 months long. And our hedging is essentially that we buy forward. Soybean mill, we've been fairly long now for a long time. We had permission from the Board to go much longer than our normal positions, which is also between 3 and 4 months, and that has stood us in good state. So we don't use instruments. We normally go longer or shorter to make sure we remain in the market.

Next question we have relates to the proposed broiler farm acquisition in the Western Cape. And the question is, what return do we expect to generate from this acquisition bearing in mind that the farming division's returns have been quite low historically?