Scales Corporation Limited (SCL) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Scales Corporation half year results conference call. [Operator Instructions] I would now like to hand the conference over to Mr. Andy Borland, Managing Director. Please go ahead, sir.

Good morning, all. I'd like to welcome you to the Scales half year results announcement for the 6 months ending 30 June 2021. With me today is Steve Kennelly, our CFO. Earlier this morning, we lodged our results with the NZX, which included a presentation pack and we'll base our comments on this call. Steve and I'll run through the slides and we'll take questions. On agenda, we'll move on to Slide 2 showing the agenda. And moving to Slide 4 and some first half financial and operational highlights for the group. Despite a period with the significant challenges, we're extremely pleased to report a half year underlying NPAT of $33.3 million and an underlying EBITDA of $54.8 million, up 15.4% and 11%, respectively, on the prior period. Please note that we've amended the definition of underlying in line with current market practice so that it now includes the effects of NZ IFRS 16 leases. Steve will touch on this in more detail later. The reported NPAT was $32.6 million, up 17.5%. Scales Logistics has continued to prove its strategic worth managing to procure sufficient containers to allow its customers to export their product. This was a significant achievement in the current supply chain environment. Mr Apple made an extraordinary effort to pick and pack its harvest despite uncertainties around labor Its forecast export volume of 3.6 million TCEs was affected by inclement weather during the key growing period. However, to date, it's achieved strong prices on those volumes. There was continued strong demand within Food Ingredients with increased volumes resulting in an excellent outcome for the period. I'll touch on each of the divisions in more detail shortly. Moving on to an update on both COVID-19 and sustainability. The subtitle of slide says it all. Without our team, we wouldn't be able to operate either in or out of lockdown. So the safety of our people was our primary priority. As has previously been the case, our businesses are privileged to be classed as essential and so have continued to operate during this current lockdown. Whilst picking and packing of our harvest was completed prior to the lockdown announcement, our pandemic preparedness policies once again showed -- allowed the remainder of our business operations to transition smoothly to lockdown procedures. Notwithstanding the current situation, COVID-19 protocols had remained in place throughout the apple harvest and packing season. This included procedures such as increased sanitation levels, gloves and masks. However, we expect disruption to domestic and international operations to continue, including labor availability, global supply -- global markets and supply chains. We've continued to focus on environmental matters together with the health and safety of our team members and market regulations. In terms of environmental projects, we're nearing the end of our carbon sequestration project in respect of apple tree plants -- plantings with Auckland University of Technology, AUT. We've seen some pleasing results and look forward to sharing more details of this in our annual report. The health and safety of our team continues to be of the highest importance, particularly given the recent COVID-19 outbreak. It's imperative that our people feel safe -- feel they are safe when coming to work. Projects that we've worked on over the last 6 months included a pilot scheme with a number of industry participants, WorkSafe and ACC to develop a multidisciplinary approach to injury prevention and reduction during the peak harvest period and mental well-being strategies to support team members at all levels. Mental welfare is as important to us as physical health, and we're keen to ensure there's a culture of overall well-being within our businesses. Meeting or exceeding market and customer requirements for food safety continues to be imperative to our businesses, and we're pleased to be asked to take part in the pilot project with MPI and others to develop a prototype digital supply chain. This with the aim of helping MPI build an end-to-end digital supply chain, allowing projects to be tracked and traced. We also continue to ensure compliance with relevant certifications and audits and recently completed the China customs audit, ensuring continued access to China markets. I'll now pass over to Steve to discuss the financial results for the first half of the year.

Thanks, Andy. Turning to Slide 9 and our group financial performance. As Andy previously noted, group underlying NPAT for the first 6 months to 30 June 2021 was $33.3 million with underlying EBITDA of $54.8 million. As shown in the table on this slide, we've included the effects of NZ IFRS 16 leases within our underlying results, and this is in line with current market practice and we've restated our comparative figures accordingly. Also shown on this slide is the reconciliation of our underlying earnings to our reported results. And I'd also refer everyone to Appendix 1 of the presentation for a more detailed reconciliation of the effect of IFRS 16, both on NPAT and on EBITDA. At a high level, for the half year, the effect of IFRS 16 is to add $5.5 million to underlying EBITDA, but to reduce underlying NPAT by $200,000. Moving on to Slide 10. You'll see a summary of our divisional performance, highlighting the excellent results achieved by our Horticulture and Food Ingredients divisions. As Andy mentioned earlier, the Horticulture division benefited from strong prices on lower export volumes, resulting in a 2.9% increase in underlying EBITDA. Maintaining diversified markets and varieties has assisted the division to achieve this result. Food Ingredients continued to benefit from increased pet food demand together with changes in its product mix and margin, resulting in an increase of $5.1 million in underlying EBITDA. Unfortunately, Logistics was affected by lower export volumes, particularly stone fruit. However, its strategic value is difficult to quantify, and Andy will touch on this again later. Turning to our balance sheet on Slide 11. Our financial position remains strong. Whilst net cash decreased by $16.8 million to $38 million, this was primarily due to 2 factors: CapEx spend, including investment in our new Whakatu cool store and ongoing Orchard redevelopment together with other projects; and an increase in working capital, specifically Food Ingredients inventories due to shipping delays at overseas ports. The value of our agricultural produce inventory at 30 June 2021 compared to the prior year remained steady. Whilst there was a lower volume of unsold crop at balance date, it was valued at a higher price compared to the prior year. As noted on the slide, around 27% of fruit remains to be sold as at today's date. I'll now hand you back to Andy, who will give you a further update on each division.

Thanks, Steve. Turning to Slide 13. As previously mentioned, the Horticulture division delivered a strong result despite being impacted by a shortage of skilled RSE workforce as well as increased labor and shipping costs. The RSE scheme is incredibly important not only to the Horticulture division, but also to the industry as a whole. Mr Apple employed approximately 14% less RSE workers over the key February to April harvest period compared to 2020. But we're pleased to be able to supplement our workforce with New Zealanders and Working Holiday Scheme workers. We're extremely grateful to the entire Mr Apple team for their extraordinary effort to pick, pack and export this year's harvest. At our ASM, Tim Goodacre noted the vital role that RSE workers have played in enabling our overall company growth. A 37% increase in RSE workers over the period 2012 to 2020 has helped Mr Apple to increase its permanent staff numbers by 111%. Also the skills acquired and wages earned are highly beneficial to RSE workers, the Whanau and their home communities, and we're delighted to support the recent announcement by the government to allow additional workers into New Zealand from selected Pacific communities. Whilst continuation of the RSE scheme continues to be critical to our operations, the overall landscape around the availability and cost of labor has changed. We believe efficiency in returns can be improved through automation. And as a result, we've commenced a 10-year investment in automation plan at Mr Apple. Our initial focus is on post-harvest activities with the first step being the commissioning of our new Whakatu cool store earlier this year. The cool store is already delivering a number of efficiencies, including reduced power consumption; decreasing the double handling of fruit, which lowers the amount of fruit damage as well as labor cost; and reduction in transportation costs and carbon emissions. The next stage of our plan is to fully automate the Whakatu packhouse, a 3- to 4-year project, that will significantly increase labor productivity, reduce the number of human touch points and potentially lead to 24/7 packing, allowing greater freight and labor efficiency. On-Orchard automation and technology solutions are also actively being monitored and considered and these are likely to follow the packhouse upgrade project. Turning to Slide 15 and details. Mr Apple's volumes. As mentioned, this year's crop was affected by inclement weather during the key growing season, resulting in a lower own grown volume of around 3.6 million TCEs. Our export packout is approximately 73%, also slightly lower than last year's rate of 76%, with our equipment efficiently grading the fruit for export. Importantly, nonexport grade fruit does not go to waste for the sold domestically, juice for Profruit or sold for further processing. Premium variety volumes continued to grow with a 9% increase compared to last year, and there was considerable growth in the sales of our new premium Dazzle and Posy apples. There was a drop in volumes of traditional varieties this year due to a combination of our planned redevelopment program and weather impacts. Moving to Slide 16. As in previous years, our strategy of varietal, geographical and channel diversification proved to be a benefit during a period of worldwide uncertainty. To date, the Asia and Middle East markets and U.K. markets have been positive. The European market has been impacted by the lower volumes from traditional varieties available, but a lower European crop is expected to both improve and lengthen the season for us. Pricing has remained firm with prices being achieved that are mainly above or in line with last year. And Fern Ridge Fresh continues to ship a pleasing level of alternative products, including kiwifruit and pears. Moving to Slide 17. The Horticulture division continues to build its branding and marketing strategies with one of its strategies being to maximize its appeal to consumers as well as wholesalers and retailers, particularly in the Asia and Middle East markets. Some initiatives Mr Apple has implemented are noted on this slide, including increased social media, increased store promotions and packaging innovations to appeal to consumer -- customers, as shown in the photos. This has proven to be successful with their retail, e-commerce and omni or multichannel sales accounting for a significant 76% of China sales in 2020. To support these channels, our flagship TMALL store is now operational and selling a range of Mr Apple products directly to China consumers and sales of Dazzle also being made through selective high-end Chinese retailers such as Hema. This -- moving to Slide 18. The next slide demonstrates some of the social media activity carried out by our marketing team. Mr Apple has a presence on a variety of social media platforms across Asia and has been undertaking campaign since May that are designed to build our brand with consumers. These campaigns are expected to run through to September. Moving on to the Food Ingredients division on Slide 19. Food Ingredients experienced another strong performance in the first 6 months of the year with 46% increase in profitability. Together with increases in volumes sold compared to the same period last year, the division benefited from changes in product mix and margin within the individual business operations. Our Australian operations were somewhat affected by the publicized supply chain issues. However, our geographical diversification again proved to be advantageous, which shall be benefiting from having a domestic customer base. Whilst Profruit also encountered supply chain difficulties for its export sales, strong domestic sales helped -- largely helped to offset these effects. Turning to Logistics on Slide 20. The current domestic and global supply chain issues have been widely reported and Scales Logistics was not immune to these problems. However, an exceptional effort by Kent Ritchie and his team procure sufficient refrigerated containers for their Horticulture and other primary sector customers, ensured the successful shipping of all harvests. The team's expertise continues to pay dividends for all our customers. Whilst there is a slight decrease in earnings for the division primarily due to reduced volumes of agricultural exports, the strategic value of the business far outweighs any financial benefit. Given the likelihood of ongoing supply chain disruptions having expertly managed and dedicated international freight services business is expected to be highly advantageous. Lastly, moving on to the full year outlook on Slide 22. Following on a strong first half period, we're pleased to report that we've upgraded our previously advised guidance for the full year. We now anticipate that our full year underlying net profit will be between $32 million and $37 million, inclusive of the effect of NZ IFRS 16 leases. This implies an underlying EBITDA range of between $65 million and $72 million, also inclusive of the effect of NZ IFRS 16. We expect that the Horticulture division will experience ongoing disruptions in global markets and logistics, together with difficulties around the availability and cost of labor. However, as mentioned, we've commenced a significant investment in automation and technology in order to increase efficiency throughout the business. A positive full year performance is expected from Food Ingredients. Whilst we incurred significant transaction costs following an unsuccessful acquisition of Villa Maria, we continue to proactively seek and review potential investment opportunities. We believe we're well positioned to take advantage of opportunities although we'll continue to proceed with caution in the current business environment. Looking forward further, we expect the '22 financial year will continue to feel the effects of COVID and particularly in respect of the availability in cost of global supply chain logistics. We will obviously continue to monitor this situation and develop strategies to minimize its impact. That concludes today's formal presentation. Although, we would point you towards Appendix 1 of the presentation pack, which provides additional financial information and reconciles underlying earnings to reported earnings for each of our divisions as well as the group. We're happy now to take questions.

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

Steve and Andy, congrats on a strong result in what must have been a pretty challenging period. I guess the first question for me is just around margin expectations. I mean, at the full year result for FY '20, you had a chart of EBIT margin and sort of outlook. And this year, the adjusted EBIT margin was around 8% give or take. I mean, you appear to be tracking [indiscernible] for this full year. I mean what's being different versus your expectations? And what can we expect to see going forward?

Well, I think that -- Guy, I reckon -- I think the main impact has obviously been -- in the Horticulture business has been the prices. We -- New Zealand had a reduced national crop due to the huge hail event in Nelson, but also we had some lost volume. And also there was less volume picked because of the labor shortage across the country. So I think, yes, I mean a lower New Zealand crop did help hold prices and lift prices across the sales season. But also hugely impressed by the Mr Apple performance around seeking a premium for our premium apples and getting them there on time in a difficult environment. So I think from that perspective, it's been a great outcome for the team.

How are those premium varieties pricing compared to the expectations I guess now you've got more commercial volume?

Very pleased with them. The Dazzle, the Posy, even though it had a very strong year with Queens again this year, and very pleased with the way those premium apple prices are going.

Okay. And I guess the other part of the question is just about the margin outlook. Is that kind of track that you had at the last result? Is that still relevant? Or are we going to move [indiscernible]

Well, I think it is still relevant because it's -- the efforts we're putting into restoring margin around the replanting, more efficient Orchard management practices through both the thinning, the pruning and the harvesting, but also moving towards lower -- more automation and also even though the new Whakatu cool store kicked in this year -- operational from day 1. And having a large cool store at our biggest packhouse has been a benefit, absolutely.

Okay. I guess just one more. Obviously, a big lift in volume from Food Ingredients, but also there seems to be a reasonable lift in either dollar margin per kg. I guess mix changes are called out. Can you give us a little bit more color on the drivers of those?

Well, clearly, the strong performer in Food Ingredients was the Shelby business. I mean, the team there have absolutely continued to operate under incredibly difficult COVID environment. But -- so our Amarillo plants continued on a -- commissioned their Dodge City -- the new Dodge City plant that got operating. And then just strong demand coming out of all those big customers up there in the U.S. And Brett Frank and all his team just continue to find good markets for the product that they were moving and very pleased with that performance. And the rest of the business, back here, the New Zealand and Australian and international business has been strong as well.

For demand where's the supply coming from? Are you able to -- clearly able to source products to meet that?

Yes. Well, clearly, I mean, because that's where you've seen the big lifts in production and the volumes traded. It was more volume both out of New Zealand and Australia, but also significantly out of America -- out of the U.S. market, again. Strong connections with the meat packers and the ability to move more volume through likes of that Dodge City plant.

Your next question comes from Joshua Dale from Craigs Investment Partners.

Just 3 questions from me. First one, you've upgraded underlying NPAT guidance at the midpoint by around [ 13%. ] A good part of the upgrade appears to be from Food Ingredients, which is partly owned by Shelby's minorities. My question is, what is the upgrade to Scales equity holders?

Steve, do you want to answer that one?

Yes. Yes, good question. We've only -- when we've advised guidance, we've only have given the NPAT including minority interest level. So we don't give guidance on the NPAT attributable to our shareholders. Yes, it's just -- it's inclusive of minorities.

Okay. Is it reasonable being to look at -- I guess, there was probably about an 8% lift in [indiscernible] the interim results. Is that probably the figure for the full year just on the [indiscernible]?

I would have thought it's higher than that, but I'd have to go back and work that out. It's not -- yes, we haven't focused on that number.

Okay. And the second question, is there any comment you can make on dividends given the upgrade?

What was that question again, sorry?

Is there any comment you can make on dividends either for the interim result or the full year, given the upgrade to guidance?

Well, I just think we'll continue to running a policy of paying a dividend that I think it's -- we declared 65% to 75% range, Steve, of NPAT?

Yes, 65% to 75% and having that minimum of 19%, whilst supported by NPAT, but we consider the dividend November, December. But yes, I don't think the expectation is for any change to that.

Great. And last question from me. You sort of talked about the Food Ingredients division in an earlier question, but obviously, volumes have increased 30%, but I'm curious about the pricing environment. Are you, for the most part, a price taker? Or is there some scope to lift pricing as different brands compete for your supply?

Look, I think the point there is that we are a strong player in the market. We have very strong relationships with both the meat packing, freezing -- the meat industry of Australia, New Zealand and America. And very good customer base who looking for the proteins that we're sourcing for them. So I just think it's -- a strong strategic positioning is assisting us to meet our customers' expectations and requirements. The range of products we've got is, I think, advantageous to us as well.

Your next question comes from Christian Bell of Jarden.

Sorry, a number of questions for me. So please bear with me. First one, our supply chain is now worse compared to earlier updates in the year. And then does your guidance for the remainder of the year is showing disruption as it is now? Or do you assume some sort of easing at some point in the remainder of the year?

I think that -- I don't know if they're getting worse per se. I think they're just continuing to be very difficult. So that would be -- and that's our assumption that they carry on being difficult, but we have got more 27-odd percent of the apples to sell. Probably less so to ship because some of it is still in the market, but we've got to get those last apples across there. We've got to continue getting the pet food across there. We've got to continue to servicing our customers across the Scales Logistics customer base. And it hasn't stopped the supply chain, so it just continues, but in, I guess, a disruptive way. And it's really probably a combination of without repeating at all the extra demand, but also the disruption in the ports. So we sort of factored in that continuing but not deteriorating further for the next half.

Cool. I mean it looks like the new Whakatu cool store generated some pretty decent savings. Would you be able to quantify that?

Probably haven't got it just exactly down to the last dollar, but just the common -- the rationale that we were used to be trucking bins into that area for packing and now they can just be forklift that across a concrete platform, take absolutely adjacent to the packhouse. So that has, as we said, lowered the -- so it's probably helped lift our fruit quality, lowering the damage. You put a new plant and like that, it's way more electricity efficient, energy efficient. So it's just -- Andrew van Workum has been asking for that building to be built for 20 years, probably 30. So finally got his way and it was always a good idea of just finding the time and the capital to do it. And now we've done it, we're pleased.

So just as a in terms of saving like just a few million or something like that before you consider the fact that it's creating better fruit?

Yes. I mean this is -- it would be in the millions, for sure. And it's just a very good way to get more efficiency in our business.

Cool. And then just on RSEs, I don't suppose you've got any more visibility over how many you're going to get next year? Can you sort of update it?

No. Well, the inference we got from the announcement that government made was that it would be a meaningful number because they were obviously clogging up the MIQ system, so the hope was that they would come across vaccinated, ready to go and not having to go through a hotel in Auckland. So clearly, that's subject to current issues. But we -- from the workforce that we've got in the country can get us through to until early next year. So clearly, we're hoping for a return to some sort of normalcy in the next few months.

In the workforce we've currently got, [indiscernible]

Yes. Yes. Well they can't go far anyway at the moment, but they're keen to work. I mean it's a great scheme because it's a win-win scheme. They work hard. They're paid well and they take their money home when they go.

And then just turning to the, I guess, the automation and business strategy. Has that become more of a focus -- given difficulty with the M&A, has the automation in the Horticulture business become more of a focus now?

I don't think it has anything to do with the M&A. I think it's more to do with the reality of that -- and the government announcements and policy that they're not going to encourage any agri businesses to expand -- expecting easy access to migrant labor. I mean the RSE scheme has been fully supported by the governments here and in the Pacific Islands, it's a well-organized scheme. But there's more plantings going on of apples as more kiwifruit and other horticulture practices. I don't see the labor force from overseas increasing as those crops are -- extra growth in those crops. So all of -- all the horticulture industries need to start thinking about automation and wherever they can. So I just see this more necessary due to the rising -- or the shortage of labor. I mean, we've got to be realistic about that and the cost of it.

And then just -- I'm sorry, sorry, were you still going on?

No, just the rising cost at the moment, yes.