Scales Corporation Limited (SCL) Earnings Call Transcript & Summary

Thank you for standing by and welcome to the Scales Corporation Annual Results Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Andy Borland, Managing Director. Please go ahead.

Good morning. I'd like to welcome you to the Scales' Full Year Results Announcement, for the year ending December 31, 2019. With me today is Steve Kennelly, our CFO. Earlier this morning, we launched our result with NZX which included a presentation pack that we'll base our comments on during this call. Steve and I'll run through the slides, and we'll take questions. And if you've got any further questions after the call, we'll be available for the rest of the day. The agenda for today's slide pack is similar to previous years. We'll touch on the year's highlights, the financials for both the group and the divisions, aspects of capital management, sustainability, investment strategy, governance. And finally, the outlook for the coming year, including comments on the coronavirus issue. Turning to Slide 4 and a summary of the year. Sales reported a record profit for the year of $121.6 million, which, in part, supported by -- was supported by the gains on the sale of Polarcold and Meateor New Zealand. Our underlying net profit of $36.4 million was ahead of last year and at the upper end of our previously issued guidance. Once again, the Horticulture division produced an excellent result with a divisional EBITDA of $39.7 million. The mixed regional market returns have been well documented. And whilst Mr Apple wasn't immune, a varietal mix and focus on premium apples ensured the weighted average sales price for apples remained firm. The orchard team delivered another outstanding crop with volumes of 3.8 million TCEs only just down on the record 2018 crop, notwithstanding significant levels of redevelopment in the intervening period. During 2019, we also achieved a dominant mix of premium apples. The Food Ingredients division retained its positive momentum and is well positioned for future growth opportunities. We had the first full year of trading from Shelby, and we were very pleased both financially and strategically from the performance of this investment. Moving on to the next slide, this highlights some of the principal financial operational numbers for the group, to mention some of them. The Horticulture division exported almost 6 million cartons of apples during 2019. Sales logistics traded almost 40,000 TEU equivalents and the Food Ingredients division sold 111,000 metric tons of food -- Petfood ingredients. A step-change, thanks to the acquisition of Shelby at the end of 2018. We reported another record revenue result of $485 million, the increase being principally from the prior year due to Shelby. We continue to have a strong balance sheet with $105 million in net cash available for investment. Moving to Slide 6. Scales remains committed to reinvesting the proceeds from divestment. Our investment attention is focused on 3 areas for investment. Firstly, organic growth opportunities to strengthen our existing business units. This includes a $12 million investment in new coolstore alongside our largest packhouse, at Whakatu. The coolstore will take advantage of the latest technologies and with improved design and centralization of post-harvest operations expected to generate meaningful cost efficiencies when it was completed. The Food Ingredients division has also explored a number of growth opportunities, including New Zealand led opportunities in the new joint venture company as well as opportunities in U.S.A. through Shelby. A second area of focus is acquisition growth opportunities that strengthen our existing business units. And we're also investigating investment opportunities in new sectors where we can add value from our existing sales networks, operational experience with China connections. We have reviewed and are continuing to review a number of acquisition opportunities. I'll now hand over to Steve Kennelly to comment on group's financial performance.

Thank you. The table on the right of Slide 8 summarizes our reported and underlying results. Reported revenues were up 20% from last year, due mainly to the acquisition of Shelby. Reported profit for the year includes gains on the sale of Polarcold, $73 million including interest and from the part sale of Meateor New Zealand, a total of $19.6 million. A decrease in underlying earnings is largely due to the exclusion of Polarcold, Liqueo and Meateor New Zealand food reserves and the consolidated group results in 2019, partly offset by the inclusion of Shelby's results. With the group net carrying a net cash position, our focus is on underlying impact as the best indicator of trends in the long-term financial performance. And we note that 2019 underlying impact was up 2% on 2018. The chart on Slide 9 show our group 5-year performance history at an underlying EBITDA and NPAT results. The historic results haven't been adjusted for businesses that have been divested or acquired, so they reflect the changes in group structure, particularly over 2018 and 2019. Moving on to the next slide. The chart here shows the 5-year underlying EBITDA trends for our 3 divisions. In this case, the Logistics division chart has been restated to exclude Polarcold and Liqueo. Slides 11 and 12 summarize our financial position, which reflects both strategic and IFRS change. 2019 balance sheet excludes Polarcold and 50% of the Meateor New Zealand business. However, it includes the impact of IFRS 16 with a $79 million right-of-use lease asset and a $80 million lease liability now recognized on the balance sheet. With the capital changes are mostly due to the removal of Meateor New Zealand business and operations from the group accounts, whilst an increase in fixed assets, excluding the IFRS 16 assets reflects ongoing capital expenditure, mostly within Horticulture. On Slide 12, we can see the effect of our M&A activity, resulting in a net cash position at December 31, of almost $105 million. At 31 December Scales held nearly $160 million in cash and term deposits, which are available on short notice for investment opportunities. I'll hand back to Andy for a review of divisional performance.

I'll move to Horticulture, once again, generated -- this division generated record revenue of almost $265 million, an increase of 4%. This was driven by higher-than-expected own grown apple crop together with a 9% increase in external grower volumes. Underlying divisional EBITDA and EBIT were $39.7 million and $30.9 million, respectively. These are excellent results, especially having regards at the mixed regional market returns. We are satisfied with our long-term strategic decisions made over the past 12 years have minimized -- immunized sorry, this business well for such market events. In addition to continuing to read about Orchards, Mr Apple achieved movements in its profitability margins and more specifically, initiatives to improve EBIT margin over the medium term. Some of these initiatives include investments on orchard and across their post-harvest infrastructure to improve efficiencies through layout, the use of automation and technology and having key infrastructure will then close proximity of each other. I previously mentioned Mr Apple's investment in our new coolstore, which is in addition to business efficiencies, is expected to significantly reduce truck movements and our carbon footprint as well. As recent developments come in maturity, we would expect to see a neat improvement in margin from 2022. Charts on Slide 15 track the long run performance of Mr. Apple, showing the growth in export volume since 2011. And as previously mentioned, the 2019 is a strong result having regard to recent orchard redevelopment. We're also pleased to report a crop mix with premium volumes now outnumber traditional. Strong volume growth was achieved in New Zealand Queen up 18%, High Colour, Sports and Royal Gala and Fuji up 9% and other premium apples, including Dazzle, Posy and Rose and others. Slide 16 summarizes Horticulture's main KPIs. Our weighted average FOB price was similar to 2018. This reflected the change in mix, improved pricing for premium varieties offset by more mixed results for traditional varieties and was despite smaller fruit size. We also benefited from small but positive FX movements with existing cover in place. Mr Apple expects to achieve similar FX rates in 2020 as achieved in 2019. Total exported volumes across the division increased by 2% to nearly 6 million TCE. Slide 17. We believe our long-term investments in orchard redevelopment have positioned Mr Apple well to deliver consistent results, with strong diversification of our exposure to any one region or variety. It is their belief that a multi-premium variety strategy is more attractive to global retails, retailers and positions Mr Apple's harvest at the front of the line for each season. Mr Apple is nearing the second -- the end of its second phase of orchard redevelopment. This phase involves 175 hectors of Orchards with 143 hectors completed and the remaining 32 hectors scheduled for the upcoming winter. This program is focused on premium varieties where we have proprietary interest such as Dazzle and Posy. The board consistently reviews the market prospects for our existing varieties and a further phase of orchard redevelopment may be likely. Slide 18. Our market strategy is run in conjunction with support our orchard strategy. 2019 saw increased marketing activations and taking place, particularly in Asia and the Middle East to support increased volume of export sales to these regions. We continue to move towards retail and e-commerce sales channels with these now compromising around -- comprising around half of all sales. We note that whilst e-commerce represents only 2% of all volumes sold in the markets where this channel was being used such as China e-commerce represent a higher proportion of sales. We are pleased to see sales and trying to grow considerably from about 10% of all fruits sold in 2018 to 17% of all fruits sold in 2019. The strong volume growth reflects multiple factors, including our ongoing end market efforts, support from a cornerstone shareholder China Resources, support from Primary Collaboration New Zealand and a smaller domestic crop in China. Because of this last factor, we expect that China will represent a smaller percentage of sales in 2020. In 2019, we launched Posy in China. Posy is a red, very early apple. Posy has already been picked this year and a special airfreight shipment was sent to China early February for sales in selected high-end supermarkets and online platforms, such as Benlai and JD.com. The market feedback from this shipment has been very positive with JD.com selling out of all their stock within a week. A photo of an in-store display of Posy is included towards the back of the slide pack. This particular photo has been taken at an old [ A ] store, which is owned and operated by China Resources. Slide 19. In our 2018 annual results announcement, we provided a volume outlook for the Horticulture division reflecting actual and expected redevelopment. This slide has been updated to reflect actual redevelopments, including both new orchard and plantings in orchard redevelopment. In movements and other orchard redevelopment, including small leases that may have been taken on or discontinued through the year. The updated volume forecast still see the softening in volumes, albeit less than they were previously forecast but volume's increasing beyond 4 million cartons in the 2023 season. Assuming 2019 apple prices are maintained and based on expectations for off prices for new varieties, we expect that the weighted average New Zealand FOB price per TCE would increase to approximately $37 by 2023. Slide 20. Moving to Food Ingredients. A year of change, Food Ingredients has retained its history of positive momentum, both in terms of financial results and opportunities ahead. As shown in this slide, the Shelby acquisition significantly enhanced volumes of Petfood ingredients sold by the division as well as driving strong increases in reported revenue and earnings. This is offset by the loss of Meateor New Zealand operations from consolidated results following this part sale of Meateor in March. Both Shelby and the JV are progressing well. Both businesses have a number of organic opportunities -- growth opportunities ahead of them that they're working hard to develop. Profruit has also continued to operate well with juice concentrates volumes in line with last year. Moving to Slide 21. In terms of the strategy for the Food Ingredients division, we believe our initial investments have provided with a basis for continued growth and sit on the journey of becoming a $25 million EBITDA division. Market research suggests the worldwide Petfood ingredient sector is an attractive investment proposition, with the worldwide Petcare industry being estimated over USD 100 billion and growing. Whilst [ estimate for ] China petfood market is valued at USD 1.7 billion with continued growth forecast. Our opportunity to participate in the China market have been significantly enhanced as a result of the recent U.S. China trade agreement as we touch on in more detail on the outlook section. Our global strategy is to be a key provider of Petfood ingredients to a wide range of international brands and our transactions in this area provides us with significant foothold towards satisfied in the strategy. Slide 22, Logistics. 122 years old and still evolving. 2019 was also a year of change for our Logistics division, with the Polarcold settlement in May resulting in an update to the division's name. First reason we've chosen to show only the results from Logistics within the table to the right. 2019 saw a return to long run performance for Scales' logistics following an especially strong 2018 yield which benefited from large airfreight volumes due to initial pipe fall orders for our customers. Increase in sea freight and reduction in airfreight volumes marks a return to normal trading patterns for this division. Given the recent growth in Australasia in agricultural products, together with Scales logistics specialist expertise in moving fruit and perishable produce, we believe there are opportunities to grow this division. Accordingly, we're seeking and reviewing settle prospects, both organic and by acquisition. Moving across to Slide 24. Performance against benchmarks. The group achieved a Return on Capital Employed, or ROCE, of 16% in 2019, ahead of the long run target of 15%. ROCE remains at primary long run objective and performance measures, which we will continue to use and a performance measure, which we will continue to use to assess to all organic and acquisition growth opportunities. We expect that ROCE will remain at or above about 2019 levels until 2022, as investments in the Horticulture division mature. Capital expenditure. Slide 25 summarizes their CapEx for the year. Total CapEx was $15.7 million with $15 million of spend on Mr Apple on -- amongst other things, orchard redevelopment and RSE accommodation upgrades as the recognized seasonal employer scheme upgrades. The accommodation upgrades improved both the availability of as well as the standard of living for our RSE workers. Further investments in orchard redevelopment, RSE accommodation and actual expenditure on the Whakatu coolstore will mean that CapEx starts to exceed $25 million in 2020. Now on sustainability and the environment. We know that meeting our sustainability goals won't be a sprint to the finish, instead it will be a journey, where we're smart about what we do and how we do it in the most sustainable way possible. The starting of the journey is appointing Karen Morrish as the Group Health and Safety, Compliance and Sustainability Manager, would come a long way. This slide outlines only a few of the highlights -- year's highlights but in the background, we have continued to make incremental progress in a wide range of areas. Of note, this year, our second carbon footprint board has showed a slight reduction. Energy audit showed excellent energy management, and Mr Apple has put a comprehensive environmental plan in place with a team of over 20 people meeting quarterly to track progress and innovate. Sustainability people and safety. The subheading on Slide 28 sums up our business. It's all about our people. In our couple of second group-wide staff engagement survey this year, we're pleased to have seen increased engagement to 61%. Out of one of the outcomes of survey is that business units have been tasked with investigating ways they can engage with staff and communicate smarter. Leadership, bullying and harassment and mental health awareness has also been a big progress for us in the past year, and this is -- while this has been Mr Apple centric, our plan has drove out towards other divisions this year. Also, as previously mentioned, we made a significant investment in the community living environment and infrastructure for our critical RSE scheme and seasonal workers, without whom a growth would have been curtailed. We've continued to apply a high level of attention to health and safety with several improvements to support both training and traffic management team put in place. Again, one of the key roles for 2020 will be deep share learnings and resources around all businesses within the Scales group. The governance and outlook. In terms of government, Tomakin Lai and Nadine Tunley, our new Board appointees in 2019 have provided us with complementary skills and expertise in the board table throughout the year. In addition, we continue to benefit from the breadth of experience and talent from the Institute of Directors' Future Directors Programme. With this year, having Jemma McCowan attend our board meetings. We are team -- [ in ] team to maintain participation of this program going forward. Moving to the outlook. The impact on Scales of Mr Apple, in particular, from the COVID-19 upgrade remains uncertain at this time. It is expected that any impact may be mitigated by a few factors. Mr Apple is expecting a more balanced global supply situation in 2020 with sales more equally focused between Europe, U.K. and Asia. Initial shipments to Asia is scheduled to arrive at market in March and into China in mid-March. No issues with shipping to non-China markets have been experienced to-date. It appears to be a strong pipeline of sales from the e-commerce channel in Asia, balancing out a potential reduction of in-store sales. A dedicated in-house logistics operation and agents throughout Asia remain confident of the actions of authorities to facilitate a flow of fruit products, in particular. I'm just pleased to contribute product to those impacted through our agents to support those communities that are most affected by the COVID-19 outbreak. In Horticulture division an apple harvest is underway, and early indications suggest a crop in line with forecast as sales volumes are expected to reflect a bounce back in sales to Europe, and we continue in marketing and branding efforts. Whilst it remains early in the season, the indications remain supportive. In the Food Ingredients division, the one-off challenges we had in 2019 are not expected to be repeated, meaning that we expect further improvement influence from this division in 2020. Both Shelby and the division's other Petfood interests are expected to benefit from the medium-term from the inclusion of Petfood in the recent U.S.-China trade agreement, which provides for improved and faster access for these products. As always, each benefits are conditional on the continuing the political relations with parties involved. Nevertheless, we remain cautiously optimistic. Now Logistics also expects to meet its trading targets. The board has reaffirmed its previous guidance for 2020 for the underlying net profit between $30 million and $36 million, which implies an underlying EBITDA range of between $49 million and $59 million. That concludes today's formal presentation, although we point you towards a Appendix 1 of the presentation pack, which provides additional financial information to reconcile underlying earnings to reported earnings for each of our divisions as well as the group. At this time, we'd be happy to take any questions.

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

I suppose just on the first question. On your Food Ingredients business, could you just provide a bit more color as to where you see that growth hitting that $25 million target, where about do you see that coming from? Is it driven predominantly about 1 area, Shelby, Meateor New Zealand, or is it a little more broad based?

Well, we certainly -- we have ambitions for all if you like, 3 of those areas are growing. I guess, in particular, we would see a couple of new projects underway implementing this year -- last year and this year. And Shelby that will provide impetus for growth for sure. So definitely across the board, that pretty excited about what's possible in the large USA market, particularly, with Shelby.

Yes. I suppose, just digging into that a bit more. Can you provide, I suppose, what markets is Shelby mainly selling into. China, obviously, called out as an opportunity here. Is that building on existing volume or is it a brand-new market? And then, I suppose in addition, is this an expansion of your current sales product? Or do you see opportunity to move into value-added products?

I don't -- China is sort of a more of a medium-term opportunity for -- clearly, it -- new U.S.A manufacturers and brands, so we'll be excited about this change in the trade policy, so that will be seeing more product to China, we think, in the future. So Shelby supplies these brands, so does Meateor. So we sort of see it an opportunity for Meateor and the JV, our Australian business and Shelby could provide more product here. But with Shelby itself, the initiatives we put in place -- for example, we put in a new equipment in their Amarillo, Texas, plant. That's just a new product line. It's not you'd call it value add, but it's certainly just supplying more product to our existing customer base in America, and it's a fast-growing market out there. So doing more business with their key customers is the major focus.

Just one last one from me. I suppose on coronavirus. Have you actually seen any disruption to-date on sales? And then secondly, how much flexibility do you have if you can't, I suppose, ship all the volume you want to enter China to move it to the market?

No disruption at this stage. As we said earlier, the airfreight -- the posy went well. The ships are on the water now. The orders are as expected. The programs are set up. We were on a call yesterday in a board meeting with our China Resources Director, Tomakin Lai was on the call from Hong Kong. Has -- China Resources are a massive state-owned enterprise. They've been -- one of their jobs has been sent to the Wuhan area to build a hospital that's -- 1 of the parties building those hospitals, for example. But I mean, that huge Logistics businesses, I was saying the area is not, I guess, under these strict lockdowns. Are generally getting back into action, that's what he was saying is that they get work. And prioritized at the port is vegetables, prioritized at the port is medical equipment. And just below that, I guess, on the next layer, we put that crop -- fruit and other produce is prioritized to get through the ports and through customs. So yes, it's a developing situation. But we're not, I guess, in dramatic disruption from the -- clearly, Chinese New Year was a disruption. With the whole places locked down, but it is if you like, starting to get back in to market because they need those fruit -- imported fruit products up there. What was the second part of your question?

And the second part was just if there was, I suppose, additional disruption to shipping, how much flexibility do you have to sell into other markets?

Yes. Well, look, I mean, that's a beautiful -- I mean, the diverse markets and the best varieties has always been a benefit to Mr Apple, and we continue to believe that. There will be more fruit going to Europe this year than there was last year. We've got a bigger fruit size this year. Color's good. So we're in a way -- our crop quality is up on last year because we had the smaller fruit. So the larger fruit profile gives you access to even more markets. So now at this stage, whilst, yes, there's a lot of uncertainty around there this virus outbreak is going to end up. But at this stage, we're in sort of, I guess, business-as-usual mode to the extent possible.

The next question comes from Jack Crowley with Jarden.

And the first one for me. Just wondering if you could provide a little bit of color about how you're thinking about demand conditions in China this year? And I guess, in particular, given that you've had an opportunity to test demand, but the kind of airfreighted advanced Posy shipments to-date. I guess, just trying to lay out the factors of kind of a stronger domestic China crop business possibly and a shift back towards, kind of, internationally, kind of -- provided produce given a lack of domestic confidence in the supply chain over there in the kind of retail chain versus kind of wholesale supplier. And I suppose, kind of with market purchasing balance that you'd seen recently in China?

Yes. Look, I think you're right, there's a bigger need China needs crop in the market, and that's why China went so well for us last year with a shorter crop ahead. But we're sort of seeing air demand just in a different market to the crop. So we're in that market where the consumer is looking for high-quality imported fruit product. And the Mr Apple band is the most strongly followed in the market. So at this stage, their programs are looking as if you -- at our expectations. Price might be off a little bit, but the prices were incredibly good last year. So I think from our perspective, we're not seeing any dramatic downturn in programs for New Zealand crop going into China. If you've heard about channels, yes, the e-channel has really ramped back with the COVID-19 virus. And what's happening there is sales to even a store like Pagoda, for example, they have e-channel, as does China Resources with their [ mutual ]. But e-channel, if you like, distribution connections, which our fruit is expected to flow to those channels.

Got it. That's very helpful. And second one from me. I guess, obviously, there was a bit of a kind of a regional mix story that you've pointed to this year? And I guess, I understand the bias of you're more towards kind of traditional apples. But are you able to provide some color just on the extent to which you think the 10% decline in traditional apple prices was a kind of a Braeburn factor and whether that will be overcome with the kind of orchard redevelopment program? Or if you think that 10% is all, kind of, indicative of the underlying kind of softer Europe market?

No, I think your answer -- we were clear about that. I thought the last announcement of Braeburn was no -- was a challenge for us, and the volume was sort of high. We [ grabbed a lot of the line]. We told our outside growers to do the same. We're incenting them or we're not incenting them with, if you like, penalizing them if they don't reduce their Braeburn. So there, we're sort of targeting on their pulls, very clear signals to them to reduce their Braeburn volume. So it's going -- that is certainly the variety that was most challenged in Europe last year. And this year's crop from New Zealand is going to be significantly down from last year's volume and driven by across the board with people doing the redevelopment. So very much a their reduction in price was almost all attributable to Braeburn and we're going to have to keep looking at it in terms of its volume in the orchard.

Okay. That's very helpful. Next 1 from me -- I'm sorry, I'll try and be kind of relatively quick. In terms of the Petfood ingredients business, I guess, what we're saying is some supply chain issues with kind of [ regain the New Zealand ] and the coolstores filling up pretty quickly. And then obviously, the prices kind of off pretty significantly for lamb and beef over the last few months, probably with a lack of domestic food to land in China as well. Do you think there's an opportunity for you guys to pick up raw materials for Petfood ingredients well below what you have throughout the course of this fiscal year? And is that something that we should be contemplating as a earnings driver into 2020?

So generally, we buy for a reasonable periods of time. We buy for the '19, '20 [ seed ] killing season, and we then [ sell ] that same product. So sort of next year's story that one. But generally, we're sitting in the middle with the buy and then the sell. So it's lower prices probably do help a little bit, particularly with the big manufacturers looking to maybe include more of it, if it's at a lower price, like lamb and venison. So yes, I think, possible benefit. But I get that general flows are that the Petfood material does need to leave their plants. They can't stockpile it at the plant. So we have the process of us taking it as a very much out of necessity. And really, we are providing sort of a service, if you like. But now I think it should be net positive, but it's not hugely impact all that.

Got it. And final one from me. Sorry, I'll stop monopolizing the call shortly. And I guess, just wanting to get a bit of clarity. There was a comment in the pack around margin improvement from 2022 in the Horticulture division, is that kind of signaling that you expect margins to track down for time. I mean kind of start to recover from 2022? Or that you think 2022 margins will be above current levels? Or could you just kind of, I suppose, provide a little bit more detail on what the exact kind of message being communicated there is?

Well, I think that's a function of -- yes, margins are challenged at the moment. The labor rates, particularly, going up. So work we're doing to mitigate at the moment is around the technology, the less people in the packhouse. Technology has driven us to more technology [ in their bins ]. So we've linked back to our payroll, so there's a lot less people in their pay administration area. So those sort of initiatives are underway. But in 2022, we're really talking about Dazzle and Posy kicking in at reasonable volumes at higher prices as a -- in a way a mitigant to the pressure on costs.

Got it. So it's not a signal about kind of where margins go in the interim between now and 2022, just about what you see is happening in the year?

Yes, we're fighting to hold the current margin. I think we talked about it in the pack and then improve on 2022 with these in the next phase of the redevelopment kicks in at the higher prices.

The next question comes from Hugh Stringleman with the Farmers Weekly.

Andy, I wonder if you could comment on the reduction in share price of almost $1 over the last 3 months? And maybe [ the front end ] of that might have been market expectations of coronavirus impacts on your trade? And secondly, why do you -- why does the board delay the declaration of a dividend for 3 months -- I'm sorry, please?

Thanks. Well, the share price, I am -- I have to -- hard for me to speak to that on that one. I think the market's -- market to market on that one, clearly, this last 2 or 3 or month, is probably been COVID-19 impact on all of New Zealand's -- listed agribusiness companies. And so yes, I would bet the markets guess, making its decisions and its investment decisions as they do. On the board, delaying the dividend, I think we're in a flow now. It's a [ patent run ]. It does give us an opportunity when we clear and pay that later in the year to see what this year's harvest is like. So it's a key driver of our financial performance. Even -- I think at the moment, it has to be a fairly bad harvest for us not to pay a dividend at the same level of last year because of this net cash position we're in, and we've stated that. So yes, just the flow we're in. And I think it's -- it works for us, and what we're going to probably continue to do it.