Q2 2020 Earnings Call

Greetings and welcome to de Sapporo, Inc. fiscal 2022nd quarter results conference call. During the presentation. All participants will be in listen only mode. Afterwards, we will conduct a question and answer session.

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Reminder, this conference is being recorded on Thursday November seven 2019, I would now like to turn the conference over to you know some poodle. Please go ahead Sir.

Thank you Frank.

Good afternoon, everyone and thank you for joining us today, a press release detailing our 2020 second quarter results was issued earlier today and is also available as we speak on our website triple double used to put all dotcom it'd probably be recorded it will be posted on our website for future reference.

I'd like to specify that are listeners on the phone and on the internet as well as journalist or on a listen only mode members of the media are invited to other questions by phone after this call.

Before we proceed please be reminded that some of the statements provided during this call are forward looking such statements are based on assumptions that are subject to risks and uncertainties.

Refer to our cautionary statements regarding forward looking information in our annual reports and our releases and filing.

Please treat any forward looking information would caution as our actual results could differ materially.

We do not accept any obligation to update this information except as required under securities legislation.

Well you know we support a junior chair of the Board and Chief Executive Officer will begin this conference by providing a brief overview of key highlights relating to the second quarter fiscal 2020 after which he along with Maxim TV, Our Chief Financial Officer in card Bachman, President and Chief operating Officer, <unk> Inc. and the international sector will proceed.

To answer your question.

Thank you Sandy and good afternoon to all our fiscal 2022nd quarter results were released this morning, and I'm pleased to see we're making great progress despite facing persistent headwinds.

These results reflect the ground work, we've laid to our recent acquisitions and I'm delighted with our evolution.

Consolidated revenues increased by 7.2% and adjusted EBITDA grew by 24% to $394.4 million.

These increases were driven by many factors, including the addition of our Europe sector.

Higher international selling prices of cheese, and dairy ingredients higher domestic selling prices in Canada and in the international sector.

Favorable market conditions in the U.S. improved operational efficiencies and lower warehousing and logistics costs.

However, our results were impacted by lower sales volumes in the fluid milk category in Canada, and reduced raw milk availability in Australia.

Accordingly, the kind of the sector will continue to place efforts on securing profitable sales volumes to counterbalance competitive market conditions, which by the way appears to be waning and intensity further concentrate on specialty and value added products and leverage consumer and cut.

Summer loyalty.

Despite current domestic commodity market conditions in the U.S., we're now experiencing a better equilibrium between supply and demand of dairy products.

The sector will continue to focus on operational efficiencies and cost controls to mitigate the impact that dairy commodity market fluctuations competitive not a competitive market conditions.

And hi, warehousing and logistics costs.

The international sector, which includes both Australia, and Argentina, well keep optimizing its product mix and customer portfolio in all markets, while emphasizing innovation.

In Australia, we continue to feel the impact of decreased milk production in various parts of the country.

As we advance in fiscal 2020, we expect continued competition in the sourcing of raw milk to persist putting pressure on margins.

Helped compensate our dairy division, Australia will employ alternate measures to assist in increasing the amount of melting processed in our plants.

We intend to remain flexible and agile leveraging our entire Australian platform to produce the right products in the right facilities and in the right quantities.

Last week, we concluded the acquisition of the specialty cheese business supply and dairy and drinks, which produces markets and distribute a variety of specialty cheese is under well known brands such as South Cape Cod, meaning Heritage Mercy Valley and Kings Island dairy.

We're thrilled to walk on 400, new colleagues to our team in Australia as well as at two manufacturing facilities in Bernie and Kings Island, both entice mania to our portfolio.

In the UK, we remain committed to aligning processes and systems wash sharing best practices.

During the quarter, we completed a public offering and a concurrent private placement raising gross proceeds of approximately $659 million.

This equity offering it's part of our company's capital management strategy and aims to Delever, our balance sheet as we target a ratio of approximately two times net debt to adjusted EBITDA on a long term basis.

We strive to maintain a well balanced capital structure, keeping shareholder value creation at the forefront of our strategy.

As leaders in these dairy industry, we will pursue our growth strategy with a disciplined and responsible approach.

Approach that also and beds this approval promise and everything we do.

For us pursuing growth as a global dairy processor includes building a healthier future for our employees consumers customers and those living in the communities where we operate.

For the remainder of fiscal 2020, our strategy remains clear.

We will do all we can to mitigate downward market pressures as well, let's focus on operational efficiencies and all our business segments.

With a strong management structure and it devoted team of talented and driven employees.

We will continue to push our business forward I.

I think all of them for their passion.

And their dedication.

On that note. We will now proceed to answer your questions Frank.

Thank you.

If you would like to registry question. Please press star one fall by the four on your telephone.

You will hear a three Tom prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration. Please press the one fall by the three one moment. Please for the first question.

[laughter].

Our first question comes from Irene Nattel with RBC capital markets. Please proceed.

Thanks, and good afternoon, everyone.

I think on the last call I said that you sounded less cautious and certainly these numbers bear that out so I actually moved through the rest of the year could you just talk a little bit about particularly in the U.S. and in Canada.

What has shifted other than the dairy you know sort of the cheese pricing and how do you think the situation evolves as we move through 22 calendar 2020.

Yes. Thank you very much for that question Irene So what do you think about the the overall market.

There's a better balance between supply and demand.

And of course that has an impact on our selling prices up very good perhaps less relevant here in Canada, but more relevant for the U.S. So let me let me talk about these individually.

In the wet.

With a rise of the block price that has all created a great environment for us to be able to mitigate some of the headwinds we have coming from say the bike products.

And so that has been a positive catalyst for us at achieving their results in our cheese business.

In this quarter here.

As well in the U.S. platform, we I have the FCC rollout program out of the SDN platform.

And so now our team and SDF have gone back to operating the business the way they know how to operate the business and our results I would say NFC at our favorable.

And and and if I can say this out perhaps in a very simple term they seem to have gotten their mojo back.

So we're delighted with the progress of the U.S. team has has gained over the course of these last quarters.

I'm I'm delighted about their productivity.

In taking the right decision at the right time.

Not getting overwhelmed by market conditions, not by being overwhelmed by some of the challenges that we throw at them just like the S&P rollout and conversion.

And just try to find solutions.

Every single day, while they're operating the business. So I'm very very proud of the progress that the U.S. team has made.

SDF is back on track a USA cheese or is it has a written the wave of of the rise in the block price and fill our feeling the effect of.

Not so much value in the bike products, but the finding other ways to create value in that platform.

On the Canadian front, a little bit different story of course is it all with the milk supply non system supply demand if not the issue. What is the issue was in Canada was the irresponsible behavior of our competitors when it comes to pricing product on the market.

Perhaps you may have seen some changes within the structure of our competitors, who I think realize that that is not a winning model I'm more optimistic going into.

The next quarters, then I was coming out of the previous quarters. In addition to that though I have to complement our Canadian team for Rightsizing. The business. So we lost a chunk of volume a when odds are piece came out at unreasonable prices.

We were disciplined enough to draw the line.

And tell our customers that at those prices, we can no longer service them.

They have taken.

Good immediate actions are rightsize the business that means unfortunately, sometimes some layoffs in certain key areas.

And some realignments in our manufacturing footprint.

As it turned out our competitor in some markets weren't able to service as effectively as they had promised that's all the retailers come back to us.

And we're prepared to take them back under our terms and our conditions.

That makes us that much more efficient and that makes us that much more effective and so again with the with the steadfast leadership, we had in all divisions in North America, whether it would be on the SDF side on the cheese USA side and in Canada.

We are showing the results that were showing this quarter and I would say unless.

There would be other irresponsible behavior or perhaps market collapse I expect this to continue moving forward.

That's very helpful. Thanks, and voice definitely had their slag or when we were down probably are down in the U.S., but.

One other question if I might just on the international side. There are so many moving pieces and in that segment with the lower the sharply lower milk in taken the lower pay so in lower way demand and there's just an awful lot going on Lino. If you could wouldn't mind, just taking a moment and walking us through.

The put or actually mostly it takes in that segment this quarter and again, how you see that start playing trail.

So if I look at.

Just a those different markets individually.

So if we look at Australia as an example, yes the milk intake is down.

But there are two we've got some very agile operators in the field that know how to take a tough decision in a tough environment.

And so I did mentioned in previous calls.

That even though our patron based milk is declining because of the decline in production in the country. We're finding alternate ways that get volume to our clients.

Essentially for US, it's it's important to get as much volume through our plans as possible to drive efficiency.

So we're looking at either co packing for others, which by the way we've been very successful at bringing in milk from some of our competitors, where we are co packing for them and we're also looking at third party milk. So off so buying milt from brokers and again on top of all of that.

What we're trying to capture the low hanging fruit.

From our newly acquired Murray Gold burn platform, Instituto dairy, Australia, and there still is quite a bit of runway for us to be able achieve some of those efficiencies. Despite the fact that we don't have as much milk as we would have originally anticipated again. This is proactive agile management. This is what we're.

All about and so.

Many times when these tough situations occur we find opportunity and then and I and I find our management team is very good to finding those opportunities.

And the same could be said for Argentinian management team.

We've got a very experienced management team in place a team that we've known since 2003 from when we acquired the business still the same people operating day to day.

They know how to navigate through the political uncertainty they know how to navigate through the environmental.

Political uncertainty.

And so we rely on their guidance to take the right decision every single day and as a management team. All we do as we provide them the support to be able take tough decisions when tough decisions are required and perhaps maybe I can ask.

Hi to provide a bit more color within either of those platforms for those two platforms offer.

Our unique opportunity to really.

Have a lot of flexibility in terms of where the raw material goes both would be the most flexible platforms of all of our divisions. If you look at Australia, we have a sessional business. We have been ingredients business, we have a fluid milk business achieved business and now a specialty cheese business.

We have the ability to ensure that we generate the highest return per liter of maximizing the yield coming of note and the same goes for Argentina as well, we do have the leaders in terms of that domestic market as well as the export market and a lot of our competitors in Argentina for a for instance don't have.

That same capabilities to have.

The export platform offer diversification opportunities, so by having us flexibility and having a laser like focus around generating the highest variable rate of return per liter of note that allows us to be successful in a volatile environment.

That's great. Thank you.

Thank you Ryan.

Our next question comes from Peter Sklar with BMO capital markets. Please proceed.

I think you pretty well covered it by going around the world I just had one question.

Like in your comments in terms of your outlook you're talking about.

The ingredients market.

Look being volatile as opposed to having.

The definitive view as to whether.

Prices are going to from or fall off I'm. Just wondering what's your thinking is on the ingredients market and.

What steps.

You know some crude oil is taking to improve your performance. There like are you talked about on previous calls how certain things like MPC 80 have become Commoditized, just wondering what steps you're taking.

Yes, so Peter I as I also indicated on previous calls.

We'd like to look at different categories of products that are value creation.

And we did that and I used. The example back in the last conference call.

Back in 2004 or five when everyone was making.

Whey powder, we made an acquisition and we made some investments the get into highly specialized whey protein concentrate.

And so we had a really good run of that probably for a good 15 years now of course, a lot of our competitors are looking at our playbook and saying, while we can be in that category as well. So ads are putting on new capacity in their plants, they're getting into those can monetize those products that were ones value added and making it commoditized.

And so now with our team of researchers.

Whether they would be within the corporate structure or in the divisional structure. We're looking at what's the next generational.

Product that we can make from our byproducts and create further value for ourselves.

And so we're always in this mode of looking at perhaps creating more value with the same raw material that we currently have we can do that similar to what we did.

In 2004 or five with WPC through the acquisition of Lando Lakes. So we can do it through an acquisition or we can develop it in house. So we're looking at all different kinds of possibilities I would not excluding acquisition I would not exclude capex allocation to products that are going to generate a higher value for those.

Raw materials that we currently have in our control.

But is there.

When you're talking about a process, but is there anything on the near term horizon that could evolve in your ingredients business.

Yes, there is.

However, I love for for the sake of competitive reasons, I don't want to get into too many of them.

But our team is quite active and on that front.

Okay. Thanks, very much I understand Peter let me so so when you're saying in the near term that technology does exist.

The ability for us to get into that does exist, but you do understand as well if it would require equipment and installation.

Many times.

It would be 18 to 24 months before we oh by the equipment get it installed and get down the plant debug. So yes, the technology is imminent.

The installation and execution might take a little bit more time.

Okay I understand thank you.

Our next question comes from Vishal Shreedhar with National Bank Financial Please proceed.

Hi, Thanks for taking my questions.

In Canada.

Yes, I know you indicated that.

Things seem to be looking up a little bit.

Just wondering as you look back to it history on the on the.

On the on the volatility of that competitive level like has as that as that period that we've just gone through been been an outlier or does this fall to the kind of.

Come and go with different machine and different pressures on the various competitors.

Yes, Thats a very good point, Michelle I think it does come with different regimes.

Let me say this.

It's unfortunate.

Really unfortunate when you have a player that comes into the dairy industry that has not from the dairy industry that doesnt understand that the cost of raw material represents 85% of your cost of goods and it takes two or three or four years to figure that out.

In the meantime, they take value out of the space and then there are gone and we're still here.

So yes, the marketplace is shifting.

We see that some of our competitors have announced that they're going to be focusing now more on profitability then volume.

That's what we've been doing since 1954 that that's who we are that's in our DNA. So we haven't changed our outlook, but we have to understand that yes.

Unforeseen sometimes history repeats itself when we got into.

The fluid milk business back in 2001, when we acquired dairy land.

Margins were minuscule in fluid milk, we brought some discipline to the market.

We brought some.

I think a lot of responsibility back to market.

And that's where the margin starting to get a little bit better in fluid milk as we weren't going after these big contract.

Just to get volume through our clients.

And quite frankly, we were getting out of.

Some commitments with customers.

If we weren't making the right returns.

So that brought a lot of discipline in the market and that discipline had been there from 2000 to all the way through just about two or three years ago to 2016.

And then all of a sudden.

Somebody wants to go after market share at all costs, so not all of us on we're going backwards back to the pre 2001 days.

So I'm hoping.

That the industry as merges lesson I'm, hoping that the players that are going to be here I think you about a long term perspective on creating value for Gary it's in their best interest. It's in the farmers best interest it's in that consumers best interest that we create value as opposed to beating each.

The other over the head with a two by four and expecting to survive.

So.

I'd like to say that.

History will not repeat itself.

I think there is a little bit of piece in the valley for now.

Either way Michelle.

We are going to survive.

We find ways to find solutions to rightsize, our business and walk away from volume if we have to underscore hoping that everyone in the industry will have the same discipline.

Okay.

Switching topics here on capital allocation.

You noted a desire to take down leverage to the two times, which which has been indicated in the past on the call. Similarly.

You indicated the possibility of strategic acquisitions for certain categories, which I think is also consistent with your prior messaging.

But just to be clear here.

Our our share repurchases out at the picture until you get your leverage target.

Yes, well for the moment from.

A share repurchase is not enough in this focus on the plan. So we tend to use the cash more in term of the deleveraging perspective and continued to Q, our capex project better than to buy back share. The we we issued some I see a couple of months ago. So it's under the radar for the next.

Future.

Okay. Thank you for your color.

Our next question comes from Michael Van out with TD Securities. Please proceed.

Thank you.

So.

Comments.

Turning to.

Trying to I guess I understand your outlook statement, because the comments sounding more positive in general.

But your net guidance comment your bottom line guidance comment for.

Slight improvement and consolidated EBITDA is unchanged so what do.

What are the that's holding you back from getting more positive on that kind of.

Bottom line outlook.

I'm glad you asked the question, Mike as I'd like to clarify that look from data. They perspective operations I think we have the right people right now we're taking the right decision.

The headwinds that were.

Thinking about that still make us a little bit reserve would be things like trade wars. There was so much volatility every single day you see it on the stock market, we see we feel it in our order patterns.

Trade Wars don't.

Any sense of comfort for anyone and they don't provide you an opportunity to think longer term not for us, but for some of our customers in some of our up the buyers of the products in the world market.

So the trade wars.

Our one element that we don't control when you think about unsettled economy possibility of recession.

Some people believed that the recession is right around the corner others think that it's a long ways out we don't know we don't control that and then also thinking about now that there is a disciplined in the market in terms of supply and demand.

Production.

It is balanced and sales continue to grow that's a very very good dynamic for the industry, but again there are two if I look at back in history anytime the dairy suppliers start to make money with raw material. The first thing they do have they put more capacity than the system and if they put more capacity that exceed.

It's consumption that we get back to an overcapacity issue, we don't control that we can try to communicate it as much as we can to the dairy farmers, but we don't control that so we still need to be cautious even though we feel good.

Where we sit you look at our balance sheet you look at the acquisitions that we made over the course of last two years over the course Alaska.

Two years of turmoil, we have grown our platform with value assets, we feel extremely good about that that's our optimism, but there's so much in the industry that we don't control that creates short term pain that forces us to remain cautious.

So it.

Trade Wars, if nothing changes on the trade front. Unlike the tariffs stays in place and all that nothing changes from where it is today.

The the economy kind of stays roughly the way it is today.

And and Theres not a huge change in the supply demand imbalance and you'd be more positive. It's just that IBX really more positive I would feel very very good about where we fit but again, we don't control those elements. Those are things that are out of our control now we like I said, Michael we could respond to it.

Secondly, but sometimes that response.

Well, we'll take some investments.

Times that response will take some time, we know for the medium long term, how we're going to find the right solutions. It's the short term.

That we have to be cautious about.

Okay and.

The only area, where I found it a little bit more confusing on your outlook statement was there.

International side because.

From.

You are kind of talk like.

Outlook makes it sound like the second half of the fiscal year is going to get tougher in Australia.

Is that the one area that you might get worse before it gets better.

Well, there could be a little bit of volatility in Argentina first and foremost after the election, we don't know what way the government's going to go with export taxes as an example.

And what that's going to mean to inflation and what that's going to mean to disposable income for the domestic market. Those are all unknowns, it's not like we havent been there before we've been there and I'm sure we're going to adjust what how long will it take us to adjust and then on the Australian side, we've got a lot of great ideas and a lot of great plans that were going to put in place with.

The current milk based that we have.

Now if the mill continues to decline, we don't think it will but there to the climate isn't changing that much and there might be more.

Deterioration of milk production in Australia that is beyond our control and then of course with a deterioration of the amount of Milt that's available well our competitors due to buy that milk.

How much will they pay for it.

Raw material as I indicated is 85% cost of goods sold that's something we need to be mindful of so that's where our caution comes in and I might ask tied to give you a little bit of color on that as well I just wanted to add also Michael that.

When we enter our third quarter, we're entering the low Nokia a low milk production cycle when you're looking at the southern hemisphere. So if you look in Australia, where that lost about 1 billion and a half a dozen milk over the last five years as well production.

1.1 of that is in Victoria, where we primarily operator.

We're going to be seeing a.

Difficult environment from a mill production standpoint.

With the weather impacts.

Situation. So there will be some headwinds as we go into the third quarter. When it comes from that's good enough for them.

Okay, and then just finally in Argentina.

The the hyper inflation seems to really be helping on the year ex that the profitability of your export sales would you say that.

Argentinian your Argentinian profit margins are above average at this point.

It all depends when the.

What is the average for.

Thats, one like Argentina, if we compare to say to prior year for the Q to Q2 results were within the zone.

Milk costs.

Thats turns around 27 cents.

To the us is comparable but slightly above.

Last year cost. So that's kind of last year was around the 20 cents more so Q2, so we definitely.

Better than the average.

As we've we've we've been having the business but.

Variable to the pricing.

Alright, thank you.

Mr. So put all there are no further questions at this time, please come to nor to presentation or closing remarks.

We thank you for taking part of this conference call. We hope you'll join us for the presentation of our fiscal 2020 third quarter results on February six have anything.

That does conclude the conference call for today, we thank you for your participation NSW. Please disconnect your lines have a great to everyone.

Thank you Frank.