Scales Corporation Limited (SCL) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Scales Corporation's Half Year Results. [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 Scale's half year results announcement for the 6 months ended 30th of June 2022. With me today is Steve Kennelly, our CFO. Earlier this morning, we lodged our results with the NZX, which included a presentation pack that we'll base our comments on during this call. Steve and I will run through the slides and then take questions and agenda is provided on Slide 2. Turning to Slide 4, and there's an overview of the period. We're pleased to report that Scales delivered a resilient 6-month result with an outstanding performance by Food Ingredients and steady earnings from Logistics, but impacted by lower results from our Horticulture division. Underlying net profit attributable to shareholders was $25.6 million, down 11.7% on the comparative period and reported NPAT was $35.1 million, up 7.5% on the same period. As a result of the sustained growth in the Food Ingredients division, together with our belief in its global potential, particularly in respect of proteins and the promising number of growth opportunities that are presenting themselves, we've made the decision to rename the division Global Proteins. I'll provide more information on this over the next few slides. Steve and I will also comment on the results for each of the divisions later in the presentation. Moving to Slide 6 and our strategy for the renamed Global Proteins division. Given the recent results of the division, its growth over the last few years and its global potential, we believe that its name should better reflect its focus. As the graphs show, volumes of pet food ingredients sold through to the end of 2021 have increased by over 600% since 2015. And underlying EBITDA has increased by over 360%. The following previously outlined strategic objectives are delivering results. The divisional 5-year EBITDA target of $25 million set in December 2018 was exceeded last year. We're creating businesses dedicated to providing key protein ingredients. We're expanding the reach of our supply networks and the range of proteins provided. We're partnering to further develop our supply network, and we're continuing to seek additional products and services. In short, our value proposition and competitive advantage together with growing global protein demand makes us confident about the future potential of the division. As you can see from the graph on Slide 7, there's a distinct correlation between the growth in pet food and growth in human edible protein demand. We believe this is due to the related drivers, including a projected increase in the global population, a rising pet ownership and humanization of pets. As a result, the disparity between protein supply and demand is anticipated to grow. We're seeking to position the group to benefit from this anticipated growth. Slide 8 depicts the current protein supply chain. As you'll see from this diagram, Scales currently operates in 2 of the 3 main areas of protein end products. An opportunity exists to expand our operations into edible products using our supplier and customer relationships together with our logistics network and our reputation for quality products. Next slide summarizes our value proposition, which is a wide range of quality ingredients and supply chain excellence. A global supplier relationships and specialized processing ability together with the skills and expertise provided by Scales' logistics mean we believe we can source and supply premium protein ingredients and deliver them on time in the desired form for our global customers. Turning to Slide 10. The critical factors in becoming a global strategic partner to our customers and suppliers include, securing global protein supply and accessing new markets to accelerate our volume growth; expanding the types of protein offered in order to simplify the procurement process for our customers; expanding our activities within the value chain to lower the cost of production for our customers and add value to them through innovation; having a global logistics network supporting our processing facilities, thus increasing the reliability of our end-to-end service and improving our brand. Slide 11 provides additional detail on our strategic objectives. We've already begun to action a number of the objectives, and we'll continue to actively work on all of these over the short to medium term. It's an exciting time for the group, and we look forward to updating you on our progress in due course. Moving to sustainability on Slide 13. Our focus for sustainability this year is to identify and confirm our future physical and transitional risks and opportunities. This will then allow us to revisit our material issues and clarify our key areas of focus. In addition, we're undertaking a group-wide baseline assessment for carbon and water and the outcome of which will feed into our future carbon and water reduction road maps. We're pleased to report that our existing projects are all continuing to progress well. I'll now pass over to Steve to discuss the financial results for the first half of the year.

Thanks, Andy. Slide 15 summarizes our group financial performance. As Andy previously noted, underlying impact attributable to shareholders for the 6 months to 30 June 2022 was $25.6 million, down 11.7% on the first half of last year. However, underlying impact was up 4% at $34.7 million, and underlying EBITDA was up 1% at $55.4 million. Slide 16 provides a summary of our divisional performance. Our group results were underpinned by sustained growth in the Global Proteins division. The division's growth was attributed to increased volumes sold together with product mix and margin changes. These result in an increase in underlying EBITDA of over 88%. In the Horticulture division, strong early in-market prices were more than offset by reduced volumes and increased costs with the division delivering an underlying EBITDA of $24 million. Logistics generated a very positive result, notwithstanding lower volumes and difficult market conditions. Its underlying EBITDA increased to $3.6 million for the 6-month period. Our balance sheet on Slide 17 continues to show a strong financial position. Net cash decreased to $16.8 million over the past year, due primarily to the following factors: higher inventory and receivables in Global Proteins, slower apple sales and increased shipping charges. The value of our agricultural produce inventory at 30 June 2022 increased by $11 million compared to 30 June 2021 due to the slower apple sales. And as at today, around 40% of the fruit remains unsold. I'll now hand you back to Andy to give a further update on the divisions.

Thanks, Steve. The graphs on Slide 19 illustrates the significant half year growth that has been experienced by the Global Proteins division over the last 5 years. Compared to the previous 6 months, underlying EBITDA increased by over 88% and volumes increased by around 13%. We expect the earnings for the second half of 2022 will be similar to those achieved in the second half of 2021. We're also encouraged by the number of organic growth opportunities that the division is investigating and developing, and we believe that these will further add to the division's growth over time. Slide 20 summarizes the results for the Horticulture division. As previously mentioned, this has been a very challenging season for the division and indeed for the pit fruit sector in general. Significant headwinds were encountered including weather, labor, logistics, international markets and increased costs. Despite the outstanding job that Mr Apple's team have done, the combined effect of these disruptions has impacted the first half result with EBITDA down 36.8% to $24 million. However, we continue to focus on the issues of increasing -- of our increasing labor costs and difficulties in labor availability and our packhouse automation project will help to address these issues. Moving on to Slide 21 and Mr Apple's volumes. As mentioned, this year's crop was affected by inclement weather during the growing season. Not only did it affect Mr Apple, but it impacted the national crop with current forecast estimating the national crop will be down around 6% lower than 2021. In addition to weather, Mr Apple's volumes were impacted by the ongoing orchard redevelopment, nonrenewal of some orchard leases and cloudy weather that affected the size and brix of the apples. As a result, Mr Apple's total own grown export volumes were down 9% on prior year at 3.3 million TCEs. Our forecast export pack out is also slightly down on last year at 75%, and we're forecasting a decrease in both premium and traditional variety volumes this year. Moving to Slide 22 and an update on Horticulture's markets and pricing. The diversification continues to prove strategically beneficial and has helped to offset some of the effects of the difficult season. Whilst global inflationary pressures and increase in the cost of living at curb consumer spending, we currently expect positive demand for the China mid-Autumn festival with steady demand in other Asian markets, such as Thailand and Singapore. Other markets are being impacted by matters such as high domestic volumes, low consumer confidence and the Ukraine-Russia war. Pricing has developed help to mitigate the lower volumes and market pressures with prices above or in line with prior year in most markets, and Mr Apple continues to focus on growing demand by branding and new varietals. Turning to Slide 23 and an update on Logistics, which has posted a strong result with underlying EBITDA of $3.6 million for the 6-month period and an increase of almost 32% on last year. Scales Logistics has once again shown its success to be strategically important to the group and to its external customers. The team's scale and expertise has provided vital services to and source solutions for its customer base. We believe we can harness this knowledge and capability in order to support the expansion of the group and be a worldwide provider of logistics services. Unfortunately, it's likely that global supply chain disruptions will continue into 2023. So we're fortunate to have such a reliable and experienced resource within the group. Moving on to the last slide on our agenda, the full year outlook for 2022. As a result of the first 6 months of trading, underlying net profit attributable to the shareholders for 2022 is now expected to be at the upper end of our previously advised range of $23.5 million to $28.5 million. Due to the change in earnings mix, the implied underlying net profit range has increased to between $35 million and $43 million, and the underlying EBITDA range has increased to between $65 million and $75 million. This updated guidance takes into account a number of factors, including Global Proteins' earnings for the second half of the year expected to be similar to the second half of 2021. Earnings from Horticulture remains subject to the success of the mid-Autumn Festival sales in China and also a stronger finish to European market sales that was experienced last year. Mr Apple currently has a higher level of fruit that is unsold compared to last year. The challenges in global logistics are expected to continue through to at least 2023. Also of note is that an increasing number of predominantly offshore opportunities to grow the Global Proteins division are being investigated, and we are excited for the potential that this could bring to the group. That concludes today's formal presentation, although I'd like to direct you to Appendix 1 of the presentation pack which provides additional financial information and reconciles the underlying earnings to reported earnings for the group and each of our divisions. We're now happy to take questions.

[Operator Instructions] The first question comes from Joshua Dale with Craig Investment Partners.

Just a few questions from me. First of all, on the Food Ingredients division, just referring to Slide 19. You've obviously nearly doubled EBITDA this half versus the same period last year. Why are you guiding to the second half being flat on the second half last year? That's quite a large deceleration?

Yes. Look, clearly, we had a really strong start to the 2022, first half year than the first quarter. And I think there was definitely COVID impacting those performance around positively. And we're just seeing they are the -- our big customers consolidating a little bit. So the demand's slowed. So it's just more of a probably reflection of a small slowdown, but not material in our customers' demand.

Okay. Great. And just looking at your Food Ingredients volumes were lifted 13%. Your earnings lifted 89%. There's clearly a lot of operating leverage there. Can you help us understand first of all, what's happened to pricing and mix and second of all of your Food Ingredients cost base, what does the split between fixed and variable costs look like?

Yes. Look, clearly, we had a mix -- benefit from the mix change. I think I reiterate the real pressure that came on with Omicron globally. Networks struggling to find the staff. So it's harder to get something, well, we got the volume and we were able to sell it for a good margin. And various -- change in mix in the products as well, which we're selling at a higher rate.

And just on your cost base, the split between fixed and variable. I mean, presumably, it's fair to say a lot of your costs are fixed on which you can get to the operating leverage?

Yes. Well, that's showing out. But I mean, probably I have to come back to you with a more detailed response to that question.

Sure. That's fine. Last question on Food Ingredients. You sort of talked to the Scales' value proposition and competitive advantage I guess from the outside looking in, I can't understand what you're doing differently from competitors? You're sort of taking off from advertiser, mixing it and freezing it and selling to pet food manufacturers, how do you differentiate in the industry?

Work harder. I think we're well positioned in providing the product from here, from Australia, from -- particularly in America with Shelby. And look, we're becoming very important to our customers. The logistics program that we run to get the products out of the meat companies. It's really our plants or in the tankers and off to the -- to the various pet food manufacturers and brands that we sell to. It's -- we believe our logistics performance is a key part of what we do there, and it's certainly appreciated by our customers.

Okay. Just switching to Horticulture. Your -- just on the unsold fruit to date, the crop was already lower than last year. Your selling rates are still lower despite that it's clearly making a bit cautious on the second half performance. Is there any sort of color you can provide on that? And I suppose your confidence around being able to sell the rest of your crop over the balance of the year?

No, we're confident of selling the crop, I guess. And you understand our accounting process and that we value the crop in full for this result. It's just the way we have to do it. But we remain confident that we'll sell through the rest of the crop absolutely.

Yes. Great. Just last question on Horticulture. Your volumes were fairly down. Just trying to get a sense of your view of what a normalized crop volume might look like if there is such thing as a normal year? But obviously, fruit size and RSE availability and cyclones impacted this result. Just trying to get a sense of to what extent the $4.3 million is abnormally low. And what do you think it should revert to assuming some sort of normality going forward?

Yes. Well, look, certainly, there's a chance for it to be -- or normal for us would be a dryer [indiscernible] Hawke's Bay, I mean, that's normal. And we certainly didn't get that this year. And so I think the -- we would be confident of it returning to what our normally expected volumes would be for sure. It was -- the -- some was wet and cloudy and it did impact fruit. We had a small cyclone event. We had Omicron through the harvest. So there was a lot of challenges, let's just say. But we feel like the labor thing is normalizing. Clearly, the RSE sort of an interesting and talked about topic at the moment. But we are fully compliant with that scheme. It's a great scheme. It's a win-win for both our RSE workers and ourselves. And we pick a good healthy crop, if you like, and good sunshine in Hawke's Bay and next year, we'll have a higher volume. There's no doubt about it.

Your next question comes from Christian Bell with Jarden.

Just a few questions from me, if I could. Sorry, the first one is a little bit long winded, but I'll just kick off with that. Just on the Global Proteins division, it has sort of already been a leader in fruit margins, obviously, extended quite significantly alongside some better product mix. But can we also put this down to the fact that it is a fragmented supply chain and your ability to provide a superior service to your customers. There is not 1 supplier that can put pressure on you and your downstream customers will be happy to continue to pay the prices that you're setting. Therefore, is there any reason why the margin gains seems -- seen so far should unwind in any material kind of way?

Look, it's a challenging -- if you like, we did keep supplying our customers through an incredibly difficult period through Omicron, through the COVID. So I think there's certainly a higher margin and performance in the business through that period and a great credit to the team. But our product mix is changing. We've made some different products in our Amarillo plant. We've commissioned their Dodge City plant that's working really well. I was just up there last week. It's a very impressive automated plant. And we're adding products, new products after -- in discussion with our customers. So that whole -- becoming strategically important to our customers is sort of what we're working on and continuing to improve on. So I think there is continuation. But we're sort of predicting the 2021 -- second half of 2022 that the gap back to our 2021 performance in the half year can be met by these future initiatives coming there in the near term. So like yes, we do remain really positive about the division and as we've said, a number of new opportunities in the pipe.

Okay. So just following on from there, because I mean, obviously, you already earlier on, you sort of alluded to the fact that there has been a bit of consolidation which might -- which could lead to, I guess, some less demand, I think you put it. But I mean the second half -- the half-on-half slowdown is a decline of 40%. And so just -- can you just help us -- and given that the downstream trends remain quite strong, can you just help us understand a little bit better why there's a 40% decline when there might be a little bit of volume decline? But then why would margins obviously -- is the kind of variable to -- is the missing variable there to sort of get to that second half '21 number?