Scales Corporation Limited (SCL) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Scales Corporation Limited 2020 Annual Results. [Operator Instructions] I would now like to hand the conference over to Mr. Andy Borland, Managing Director. Please go ahead.

Good morning, and welcome to the Scales full year results announcement for the year ended December 31, 2020. With me today is our CFO, Steve Kennelly. Earlier this morning, we lodged our results 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, then we'll take questions. 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 on Slide 2. We'll touch on the year's highlights, sustainability, the financials for both the group and the divisions, aspects of capital management, governance and finally, the outlook for the current year. Turning to Slide 4 and a summary of the year. Scales reported a pleasing result for the year, with underlying EBITDA of $53.9 million, 2% ahead of last year. Our underlying NPAT of $33.8 million was 7% down on last year, but was towards the upper end of previously issued guidance. The Horticulture division once again delivered record volumes, with 3.9 million TCEs, a 2% increase on 2019. Horticulture EBITDA was $31.4 million, down on last year due to effects of lockdowns. However, the division's diversified channels and markets mitigated some of those impacts. Mr. Apple also completed the current phase of orchard redevelopment, with 36 hectares planted during the 2020 winter. The Food Ingredients division took advantage of a strong petfood market, generating an outstanding underlying EBITDA of $23.1 million, up 71% on 2019. It also benefited from diversification of both a geographical supply network and sources of protein. The next slide highlights the selection of operational and financial numbers for the group. These include: the export of 5.7 million cartons of apples by the Horticulture division during 2020; Scales' Logistics, managing over 35,000 TEU equivalents; and the Food Ingredients division selling almost 116,000 metric ton of petfood ingredients. On the financial side, we recorded revenue of $471 million, generated a ROCE of 15% in line with our long-term target, and we continue to have a strong balance sheet with $98 million in net cash available for investment. If we can turn over to Slide 6. Whilst 2020 represented a number of challenges, we are very proud of what our team of nearly 3,000 achieved. Through teamwork, commitment and unity, Scales broke records and performed strongly. I'd like to touch on a number of those achievements. We were in the very privileged position of being deemed an essential business and able to continue operating during the 2020 lockdown, which took place during the critical apple harvest period. The bravery of our staff, who continue to turn up to work through the lockdown period, was admirable. The management team and Board are extremely proud of the entire Scales team for their courage during this period. Their safety was and always is areas of priority, and the business adopted a number of measures to ensure everyone felt safe during those uncertain times. We are pleased to confirm that all staff were paid in full and that none of the Scales businesses took advantage of the New Zealand government subsidies. Scales continue to declare and pay dividends throughout 2020, consistent with our previous communications. Scales continue to provide earnings guidance, which we are very proud to confirm was met.

If I can just interrupt Andy here, I'd like to touch on 1 final point that he's failed to mention. The Scales Group was also very proud to learn Andy have won a leadership award at the Infinz Awards Dinner last year. This award provides external recognition of the leadership skills and vision that Andy brings to the group, and it verifies our own internal perception of his remarkable abilities. Sorry, Andy, over to you.

Thank you very much. Moving on to sustainability. Once again, it's been a busy year for our sustainability team. In addition to ensuring that our businesses continue to operate in the safest way possible, we partnered with environmental consultants, thinkstep-anz, to update our material areas of focus. Scales is currently in the process of drafting its inaugural climate change report. From an environmental point of view, a wide range of projects, audits and certifications were carried out, as noted on this slide. Further detail on these will obviously be provided in the sustainability section of our annual report. Slide 9 summarizes the selection of the health and safety initiatives that have been expanded or developed this year. As in previous years, health and safety is the top priority of the Board and of the group in general and will continue to be so. As a result, we're pleased to report a decrease in the number and the severity of incidents this year. Touching on a couple of other initiatives, we were delighted to support communities, both in New Zealand and China, by providing apples to those in need. In New Zealand alone, we estimate that we provided around 0.5 million apples to food parks and organizations. We undertook a pay equality review during the year, with results indicating new durable differences in pay between genders. I'll now pass over to Steve to comment on the group's financial performance.

Thanks, Andy. The table on Slide 11 summarizes our underlying reported results for the group. Revenue was down 3% on last year, primarily due to a decrease in horticulture revenue, and Andy will provide further detail on this later. Underlying EBITDA increased slightly compared to 2019 due to an excellent performance by the Food Ingredients division. Underlying NPAT was down 7% on 2019 to $33.8 million, but pleasingly above the midpoint of our previously advised guidance range of $30 million to $36 million. Reported profit for the year was also down, although this was mainly due to gains on the sale of Polarcold and the 50% sale of New Zealand being included in 2019. Together, these 2 transactions provided one-off gains in 2019 of $88.5 million. Also reported this year was a $4.3 million impairment of fixed assets, primarily relating to lower valuations for certain orchard assets, such as trees and RSE accommodation. However, we note that in aggregate, the valuation of all orchards increased. Turning to Slide 12 and our group 5-year performance graphs of underlying EBITDA and NPAT. As noted last year, the historic results haven't been adjusted for businesses that we have divested or acquired, so they also show changes in group structure, particularly from 2019 onwards. Slide 13 provides a summary of our divisional performance, comparing the first and second quarters of 2020 to the comp periods of 2019. And our interim presentation highlights the seasonality experienced by the Horticulture and Logistics divisions, in particular. And a couple of points to note here, as Andy commented earlier, whilst the Horticulture division generated record export volumes, it was affected by lockdowns. As a result, whilst there was strong sales into Europe, sales patterns into Asia and EMEA markets were adversely affected. As a result, the division's results were lower than last year. Food Ingredients benefited from continued strong food demand, resulting in a significant increase in earnings compared to 2019, and Logistics continue to trade in line with prior periods. Moving on to the next slide. The charts here show the 5-year underlying EBITDA trends for our 3 divisions. This highlights the change in mix of earnings amongst the divisions compared to last year. Andy will go into this in further detail in the next section. Slides 15 and 16 summarize our financial position, which shows a relatively steady situation compared to 2019. The primary changes are: an increase in fixed assets due to CapEx on the new Mr Apple coolstore, an orchard redevelopment, amongst other projects; the sale of the Havelock North pack house included an assets held for sale as at December 31; and an increase in other assets, which is due to the revaluation of FX derivatives, in line with -- in the IFRS requirements. Slide 19 (sic) [ Slide 16 ] continues to show a strong net cash position at December 31 of almost $98 million, providing us with the ongoing ability to invest in appropriate growth opportunities as and when they arrive. I'll now hand back to Andy to update you on divisional performance.

Thanks, Steve. Slide 18 summarizes the financial results of the Horticulture division. The impact of lockdowns on the sale of projects into the Asia and Middle East affected pricing for those geographies, resulting in a 7% decrease in revenue to $246 million. Pricing, together with an increase in labor cost, impacted Horticulture's earnings, with an underlying EBITDA and EBIT down by 21% and 29%, respectively. I'll touch on our margin improvement strategies for this division in a later slide. The division continued to exceed expectations around volumes, with a 2% increase in TCEs compared to prior year and a 3% increase compared to forecast, a superb effort by the Mr Apple orchard team, premium varieties continue to be a focus for the division. The volume charts on Slide 19 continue to track the long run volume growth from 2011 onwards. Premium volumes increased 4% compared to 2019 and now account for around 57% of all exports. There were similar or increased volumes across most premium varieties, with significant percentage increases in our new varieties, including Dazzle and Posy. Slide 20 summarizes Horticulture's main KPIs. As I mentioned earlier, we encountered some tightening of pricing of our premium varieties into the Asian markets due to the impact and timing of lockdowns. For example, the China lockdown coincided with the Chinese New Year, which is typically a good period for apple sales. The decrease in pricing for premium varieties was partially offset by firming apple prices in European markets. We benefited from favorable FX movements against the U.S. dollar and continue to have cover in place for 2021, notwithstanding this recent strength in New Zealand dollar will likely lead to adverse FX shifts during 2021. Our overall exported volumes dropped slightly by 4%. However, Fern Ridge replaced a portion of its apple volumes with kiwi fruit sales, which have not been included in the reported volumes. In our interim presentation, we commented on a number of initiatives that we had identified in order to maintain or improve margins. This continues to be a focus, and Slide 21 summarizes projects of note. The completion of Mr Apple's new coolstore at Whakatu is expected to provide both operational and logistics efficiencies. And as Steve mentioned, it has allowed us to sell our Havelock North pack house. This promotes greater centralization of our post-harvest operations. Mr Apple completed the second phase of its orchard redevelopment during 2020, with around 36 hectares planted or redeveloped as focus over this phase of planning was in high-value varieties such as Dazzle, together with incorporating 2-dimensional planting techniques. Accordingly, we anticipate higher prices and yields as these orchards reach commercial scale. As shown on the chart at the bottom of the page, significant commercial volumes from recent plantings are expected in 2023 onwards. We acknowledge that the environment for the availability and cost of labor has changed. As a result, we expect to accelerate automation initiatives, particularly in the post-harvest area. We expect to commit to certain automation initiatives during the current year. Having said that, the RSE scheme at pre-COVID levels is and will remain critical to our ability to pick and pack our harvest. Turning to Slide 22. It's important that the Horticulture division continues to identify innovative strategies for market penetration, particularly in the Asia and Middle East markets. These markets continue to comprise a significant portion of our sales at 62% of exports. China itself accounted for around 17% of export volumes in 2020, in line with 2019. In order to support this activity, we're delighted to note we've recruited a new senior marketing manager. We continue our efforts to develop and grow our retail and e-commerce sales channels. These channels now account for over half of all sales. To support these channels, we're excited to roll out a number of new marketing initiative, innovations and activations in 2021. One of these is a flagship store on Tmall, a business-to-consumer online retail platform operated by the Alibaba Group, which allows international businesses to sell in market brand and go straight to consumers in China. We also expect to continue our marketing of Dazzle, which was launched through high end Chinese retailers in 2020, with targeted promotions in both Vietnam and China. Moving on to Food Ingredients on Slide 23 and its exceptional results for the year. 2020 saw significant increases in both revenue and profitability for this division, reflecting the benefit of a geographical and protein diversification strategy. With underlying EBITDA of over $23 million, the division took a considerable step towards long run EBITDA target of $25 million. And to help us satisfy this demand, Shelby entered into a new third-party warehousing and processing agreement with a toll processor in Dodge City, Kansas. This brings the number of processing facilities at Shelby to 8, its own facility in Amarillo, Texas; plus 7 toll processing facilities throughout the United States. Part of the growth can be attributed to a growth in global petfood demand as a result of increased pet ownership and adoption rates through the pandemic. However, we believe that other factors such as humanization of pets have also contributed to the increase. Profruit volumes were also up compared to last year, with a 6% increase due to high fruit brix good yields and increased retail demand. Turning to Slide 24. Market indications suggest that the global petfood industry will continue to grow, with 1 market research company suggesting it will increase at a compound annual growth rate of 6% over the period 2019 to 2029. Anecdotally, we're aware of plans for at least 2 new mega petfood plants to be built in the United States in 2021. Food Ingredients has a global strategy of being a key provider of petfood Ingredients to a wide range of international brands. And as such, we're continuing to actively analyze and review organic and transactional opportunities to expand our geographical presence in protein offering. Travel restrictions that are placed during the year limited our ability to pursue acquisition opportunities as well as limiting our ability to develop new supply and offtake relationships. On Slide 25, we summarized results for the Logistics division. COVID and lockdowns provided a few challenges for logistics, with supply chains disrupted around the world, resulting in a decrease in the volumes of both ocean and airfreight for the division. However, the impact of COVID was lessened by the division's focus on the essential agribusiness sector and reported a solid result with both underlying EBITDA and EBIT up on last year. I'll hand over to Steve to review our capital and CapEx positions.

Slide 27, our return on capital employed or ROCE parameters varied significantly between divisions dependent on their business operations. Horticulture with its high asset base generates a relatively low ROCE, whilst logistics is at the other end of the scale. Specific projects and operations also affect returns, with the Horticulture ROCE being impacted this year by a significant CapEx spend. Returns for this division are expected to increase once redeveloped orchard reaches maturity, and the impact of other margin initiatives takes hit. The group ROCE remained at its long run target of 15% for the year. A summary of CapEx for the year is shown on Slide 28. The Horticulture division accounted for around 97% of total CapEx this year, with significant spend in orchard redevelopment and the Whakatu coolstore and some additional RSE accommodation upgrades. This spend was in line with expectations. As previously mentioned, future CapEx is likely to be focused on margin improvement automation and efficiencies in the Horticulture division. And the majority of our orchard redevelopment is now complete.

Moving on to governance. It was important to the Board that, notwithstanding the logistical challenges presented by COVID, good governance practices should prevail throughout. As a result, you remember that we held a virtual ASM last year, the first in over 100 years of trading. And as was the case for many businesses, Zoom meetings became the norm, with Board meetings undertaken on this platform when needed. As I mentioned previously, the entire Scales team rose through all the challenges presented to them throughout the year, and personally, I was proud to see how well and quickly they adapted to new situations. Moving to the outlook for 2021. The Board is mindful of climatic events in recent months during key growing periods, together with the continued disruptions to global supply chains. Accordingly, directors have amended the full year 2021 guidance provided on December, 9, 2020, for the group to: between $27.5 million and $33.5 million of underlying net profit; in between $46.5 million and $53.5 million of underlying EBITDA. This amended guidance range reflects lower levels of fruit exports in both Otago and the Tasman region, impacting the logistics and Horticulture divisions, respectively; lower than forecast estimates of own grown apples for Mr Apple; and delays and related increased port side charges and shipping. Whilst the group generated a strong result for 2020, the directors believe that the ongoing ripple effects of COVID will have a greater impact in the first half of 2021. As noted above, the acceleration of automation initiatives may mean that CapEx for 2021 is higher than previously indicated, although this will ultimately depend on the timing of and cost of any initiatives that are pursued. Remaining assumptions stated in our guidance from December 9 have been reaffirmed. Within the Horticulture division, we expect a lower-than-anticipated fruit volumes to be partially offset by higher end market prices. The outlook for Europe and the U.K. is positive, with a lower New Zealand crop anticipated and early sales to Asia are encouraging. Whilst there are margin headwinds for 2021, we're of the view that the majority of these challenges and additional costs will stabilize and that margin should return to 2019 levels in 2022. That concludes today's formal presentation, although we point you towards Appendix 1 of the presentation pack, which provides additional and financial information and reconciles underlying earnings to reported earnings for each of our divisions as well as the group. We're now happy to take questions.

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

Guy here. Firstly, on the large Food Ingredients growth, I mean, it looks to be a significant margin uplift. Can you just talk to the drivers of the margin shift and I guess, just how sustainable that might be?

Yes. Look, I think the demand really did pop up with COVID. We had people pantry stocking. We had shortages coming from Meateor. It's -- they prioritized the edible products ahead of Food Ingredients products. So it really become a bit tight on the supply side, so that did help margin. So I think as to the sustainability of those margins, the industry, in general, is just having a strong period of growth. We referenced a couple of those extra huge plants going in. I mean that's net increase in capacity and growth for -- to supply what is quite a buoyant petfood market, Guy. So we don't know if that percentage margin will hold where it is, but it's certainly -- it's holding solidly at the moment because I guess Shelby and Meateor are very key suppliers to the big petfood companies.

How does that flow through in terms of the raw ingredient suppliers into Meateor and Shelby? Have you had much negotiations with them around pricing? Presumably, they're also seeing the demand in petfood growth and wanting to experience the lift in prices, too?

Well, we do adjust the prices for the purchases we make, of course, but I mean, there's just -- there's different dynamics within different species, really, Guy. I mean, the -- certainly the lamb in New Zealand is competitively bid. The -- parts of the -- there've become more lamb available in Australia because some of their plants were blocked through going to China, so there was more pet -- more of the product went to petfood. And America, the meat companies, the big packing companies, it's a real -- they're producing such big volumes that the product cannot stay on their sites. So it's a, in a way, you're almost providing them a service moving it out.

Okay. On your Horticulture division and the EU margins forecast picking traction next year, what kind of costs and labor assumptions are built into that? And can you maybe just step us through into the recovery into '22 as well?

Yes. Well, obviously, we absorbed the -- from 1st of April, the increase of the minimum wage, but we -- this is co-related -- roll on of that because we are -- not all of their staff aren't on the minimum wage. Many of them are above -- paid above that, so this is just that roll on effect, so it has to be absorbed was accounted for it. Was accounted for the high cost of the MIQ hosting of over 200 -- of the -- the welcome, very welcomed new RSE workers this year. So we do sort of see the RSE reverting to normal in 2022. That's a critical requirement. We feel like it is an easy hiring than New Zealanders. I mean, there's not that many there available for the first -- the unemployment rate not really gone where the government thought it would go. So we do see the combination of reverting to the more efficient full RSE complement, definitely through more automation, and those premium varieties volumes are selling at higher prices coming through, Guy.

Okay. And so -- I mean -- how you -- with unemployment not going where previous expectations were, how are you -- position of the harvest coming up? Do you have sufficient New Zealand labor? Have you had much success in that [indiscernible]?

Well, we have sufficient total labor. I wouldn't -- now, we've got -- there was quite a number of RSE stayed behind. So they -- we've been -- we shared them around other industries throughout the year, and they're all back and they're now harvesting for us. So the combination of them and the ones we're able to get out of the 2,000 pool, if you like, our natural share of those. And also with the huge Nelson event, the weather event, there's been a few RSEs of our friends and growers, they have been able to be shared back towards us. So I would call that -- I could use the word scramble. It's going to be tight, but we have a plan in place to pick all of our fruit and pack them and export them.

[Operator Instructions] Your next question comes from Chris Byrne from Craigs Investment Partners.

Just wondering whether you can run us through the smaller crop and just the drivers behind that.