Genus PLC

LSE:GNS

Earnings Call Transcript 2023-Q2

[Stephen Wilson, CEO]

Well, welcome to our webcast of the Genus interim results for our 2023 fiscal year. Thank you for joining Alison Henriksen and me today as well as our recorded webcast. There's going to be a live question-and-answer session held later today and details are in our results release. So after the usual disclaimer on Chart 2, I'm going to be covering our business and strategic progress, and Alison is going to outline the financial performance.

However, before we start into the presentation, I want to comment briefly on the announcement made this morning that I've decided to retire from Genus on the 30th of September. I joined Genus 10 years ago. And it's something I still find hard to believe just how fast time has flown. It's really been a tremendous privilege to lead such a talented group of people and together with them, develop Genus into what it is today, a leading global agricultural biotechnology business. However, the march of time affects us all. And as I'm hitting my mid-60s, I feel the time is right to plan my retirement from a full-time executive role and pursue some other interests.

The Board has commenced a search for my replacement, and I'm committed to continue to drive the execution of our successful strategy and ensure a smooth transition when a successor has been identified.

So look, enough of all of that, let's look at the headlines of our first half FY '23 performance. And we made some good financial and strategic progress. Revenue grew 25%. Adjusted EPS grew 15%. Our performance in PIC China improved, but we also saw good growth in many other parts of our business. In fact, our PIC business had a record half year profit. Alison is going to give further details of the financial results a little bit later.

Now we've really achieved these results in markets which continue to remain quite challenging. And I'm going to give you an overview of our assessment of those market conditions around the world on the next chart. Our progress, I think, was underpinned by market share gains with key customers globally, who are recognizing the strength of our genetics and the great services our Genus colleagues provide.

We've also continued to invest in our supply chain, our systems, in research and development to support future growth. And I'm pleased with the progress we're making. Our PRRSv resistance program, that continues to progress, and I'm going to give you some further information on that in a few slides time.

And I want to thank my Genus colleagues for their commitment and passion in pursuing our consistent strategy and delivering this strong performance.

So let's first understand a bit more about what is happening in our customers' markets and the challenges they're facing. Looking around the world, North American producers made good returns in the last six months, but the market is looking a bit less favorable going forward. There's been some modest expansion of sound numbers and dairy cows, but the beef herd has actually contracted quite a bit due to drought conditions in many beef raising areas.

In Latin America, we saw actually very tough trading conditions in both dairy and beef markets, particularly in Brazil. And they're a combination of drought, oversupply, weak domestic demand, that all affected producers and drove a downturn in the market for bovine genetics. And I'd say that economic and political uncertainty in that region remains quite high.

In Europe, the pig industry has continued to contract in the last year. And I think further decline is really likely. However, dairy producers benefited from high prices, so that enabled them to be profitable despite high input costs.

Finally, in Asia, the China porcine market has continued to be very volatile, while China dairy production has continued to expand. And conditions in Australia have been favorable.

So to summarize, the global picture is always quite complex, but I would say that conditions for our customers in several quite important markets are really still challenging.

Let's look at China porcine, in particular, in more detail during the period. So what we saw was producers became profitable. The chart here shows you the ratio of pig price to corn price. And if you're above a ratio of six, then generally producers are making money. And you can see that as the pig price rose in the autumn of 2022. That started to happen. So producers actually started to hold back pigs to grow them to heavier weights in the hope of even higher prices later. That strength, however, didn't last as China experienced waves of COVID lockdowns.

So through December and running up to the Chinese New Year, the pig price actually started dropping. And due to a combination of oversupply from those heavy pigs now coming on to the market, and the strong wave of ASF in parts of China, it came down quite sharply.

In addition, the loosening of COVID controls resulted in mass infection throughout China. And so that depressed demand. So what you've seen is the price has been unexpectedly volatile in the last few months.

So it really begs the question where to from here. I think those of us that have been around this market long enough know that it's always likely to retain its capacity to surprise us.

However, industry experts believe that the price should recover during the second half of our fiscal year as the supply clears and demand strengthens with China normalizing in its post-COVID environment.

Let's so think about how our business there has been progressing, and we made good progress, particularly with robust royalty revenues. We're also encouraged by the pipeline of new business prospects. Although the timing of deliveries is uncertain and depends a bit, I think, on the shape of the market recovery that we see.

We're pleased to have started stocking a new nucleus farm at Ankang to improve our supply base. Unfortunately, however, one of our joint venture farms did get hit in this wave of ASF in January. And we've had to partially clear and clean up that farm. We anticipate we're going to be able to cover the supply of breeding stock from other farms, but we're going to incur some costs for cleaning up the disease.

Well, before we look further at the progress we've been making in PIC, I wanted to just remind you of the fundamental strengths of the business. Our strategic competitive advantage is driven by this combination of the best genetics in the industry, deep long-term relationships with the majority of the world's leading producers and unmatched global supply chain in terms of both size and quality and pioneering technology. And all of that is really underpinned and couldn't have been accomplished without a world-class team of dedicated, passionate people.

Let's see how that is adding up to a winning combination. So starting with PIC in North America. I think we're clearly gaining market share in both the sire line and dam line based on the strength of our product performance backed up by our outstanding technical service.

The PIC800, which we introduced following the Møllevang acquisition is continuing to win in customer trials demonstrating it's simply the best Duroc boar on the market, gaining share with top producers. And our PIC337 boar also continues to be very strong.

The Camborough sow continues to lead in the female side of the market, and that's been driving share gains from internal programs. You recall the transaction we did with Olymel last year and our integration of their AlphaGene program is progressing ahead of plan, both operationally and financially. And the results of these gains now clearly showing through in accelerating North America volumes and our fastest rate of royalty growth there at 10% for many years.

You can see similar progress in Latin America, driven by some of the same themes. We're illustrating here two case studies. First, in Mexico, we had no business with the second largest producer some years ago. However, our persistence in demonstrating product performance in several trials, our capability to provide technical support to help them through a disease challenge, that's led us to capturing 100% of both the maternal sow and terminal boar business.

The second case study is the largest producer in Ecuador. They've been a customer for over 20 years. They operate to great standards. And that enables them to really realize and see the genetic potential of the improvement we're delivering to them. So you can see that every year over the last five years, they've achieved more wean pigs, better feed efficiency, faster growth. So I think what you can see here is great genetics, great people, customer relationships all combining here in these examples to deliver growth.

Now let's look at how we're further strengthening our global supply chain to power even more growth and competitive advantage going forward. Since 2019, we've expanded our global elite farm capacity by over 75%. The farms we've most recently commissioned include Atlas in Canada, now fully operational. A second nucleus Genesis in Brazil, that's ready to be stocked now. And Ankang in China, which is in the course of being stocked also right now. Notice how in each of these sites, we're working on raising the bar on environmental standards from the outset to make them as low-carbon operations as we can.

Now our PRRSv project continues to make steady progress. We've significantly expanded our E2 generation of animal numbers and we're now giving birth to the E3 generation. We commissioned an additional farm this autumn to house the growing number of animals.

Meanwhile, our productive relationship with the FDA continues. We've had the first three submissions accepted and are well progressed with two further submissions. You can see them on the chart here, phenotypic characterization and food safety. And so we expect that we'll be making the formal submissions on those two very shortly.

Meanwhile, studies are continuing on the last two of the submissions, that's the phenotypic and genotypic durability and we're discussing the design of the final regulatory studies in these areas with the FDA. Our plan remains to complete all submissions by the end of this calendar year.

In addition, we're increasing our engagement with international regulatory agencies, and we see encouraging progress here.

So let's switch focus to ABS. We've been building our strategic platform in a very similar way to PIC, strong genetics, long-term relationships, a global supply chain and significant investment in technology. Once again, this is all realized and enabled by our highly talented team.

So let's start with the genetics. Our dairy genetics continue to be very competitive for profit-oriented producers. We have a very broad range of sire lines within the portfolio and are strongly leading the industry in the development of polled genetics. These are the genetics where the cows they won't have horns, and so they won't need to be dehorned by the farmer. So there's an animal welfare benefit here. In fact, ABS is over 90% of the top polled net merit sires in the industry.

In beef, our proprietary genetics continues to show great performance. And we're also developing polled genetics here in the T15 line. And those are the white ones, while the T14 line, those are the black ones, they're already naturally polled.

So let's take a look at how we're progressing in the market in North America. Alison is going to share with you a bit more the financial results for North America but I want to really illustrate how we're winning with a case study.

Here, you can see, however over number of years through demonstrating performance, providing strong service and working in partnership with the customer. We've been able to move from doing no business to doing 100% of the business. And it's wins like this that are also contributing to driving up the share of Sexcel and beef-on-dairy in our North America business.

A number of you will also be familiar with the idea that we want to create and capture more value for our NuEra beef-on-diary genetics by working across whole supply chains, where the quality of the genetics can be really appreciated. We're making progress.

In North America, a number of these networks are developing. For example, Schmucker family farms. They raise cattle, they send them to JBS to be slaughtered, and they recognize the quality and cost benefits of NuEra genetics. So working with them, we're now creating dedicated flows of NuEra beef-on-dairy animals into their system, enabling us to win new customers and to capture more value.

Similarly, in the U.K., we're growing with Warrendale to create a dedicated supply of premium beef for a leading retailer, again, enabling us to recruit more farms on to ABS genetics and capture more value.

So look, we've talked about PIC. We've talked about ABS. I want to just remind you of the innovation platform we've built in research and development. We've used this chart several times before to show how we've organized our R&D teams around four key development platforms, all supported by our genome science and bioinformatics teams. The strength and depth of our organization and talent has advanced substantially over recent years. And I'm encouraged and excited by the progress they're making across the pipeline of opportunities they're working on.

We also collaborate with several leading universities and research institutes to broaden the reach of our efforts. An example of the commercial impact coming from our R&D teams is the expansion of our sexed-semen business. We achieved continued growth in the first half, both in sales of Sexcel and in our third-party business, which we call IntelliGen.

In EMEA, we're establishing three new laboratories in the second half of this fiscal year with new customers who signed multiyear deals. Meanwhile, our business in India commenced producing and selling sexed-semen under Government of India umbrella contract aimed at accelerating the adoption of sexed-semen, which today is very low in what is a very large market, the Indian dairy market.

So finally, in the segment of the presentation, I'd like to just wrap us up by commenting on sustainability. I think as you know, genetic improvement drives sustainability for our customers enabling them to produce protein with fewer resources. That's less land, less water and lower carbon emissions. In addition, we're committed to reducing the carbon footprint of our own operations. And we're investing behind both of these themes.

You can see on the left of the chart, our testing facility for beef bulls, recently opened just outside York where we've installed state-of-the-art feed and water monitoring systems to enable more accurate genetic selection for feed efficiency in our T15, NuEra line.

Then on the right, what you can see is the manure management system at our new Ankang, Elite farm in China. It represents a huge step forward compared with the farm it replaces. And it demonstrates that we're strongly committed to achieving our 2030 goals to reduce our own carbon emissions by at least 25% and to target net-zero by 2050.

So let me now hand over to Alison to take you through the financials.

[Alison Henriksen, CFO]

Thank you, Stephen. We're all animal lovers at Genus and I've shared with you in the past, stories of some of our bovine and porcine stars. But as Stephen said, it's our people that make it all happen and we're focused on attracting and developing the best talent.

On this page, I'm sharing with you a picture of the 30 interns that joined us for work experience in the U.S. last summer. The program has been very successful with many of the interns continuing to work with us while completing their studies. And Genus has been recognized for the innovative approach taken to support the new generation of talent into the workforce. Really great work done by our recruitment team.

So now let's get into the numbers. Overall, the half year results were good, and it's great to be back in growth. In some markets, it's been tough, particularly in Latin America for ABS and Europe for PIC. But there were strong performances in North America by both businesses and PIC China had seen a gradual recovery.

In actual currency, adjusted profit before tax of £42.2 million was up 14% and this includes net finance costs of £6 million, more than double in the prior period due to rising interest rates and higher debt.

The graph to the right shows adjusted operating profit increasing to just shy of the peak in FY '21 at £48.3 million. Operating profit margin was down at 13.8%, but this was impacted by an 86% increase in gene editing costs as we move towards regulatory approval. And whilst PIC China improved its profit, their margins were not at the levels seen in FY '21 during the peak.

This period, there was a £4.8 million exchange rate benefit on the translation of overseas profits primarily from sterling weakening against Latin American currencies. But unfortunately, this gain was mostly eaten up by high interest. At today's spot rates, we estimate that the benefit for the full year will be around £6 million to £8 million.

As you heard, we're making good progress with the PRRS program, and we've expanded our porcine supply chain. Thus, we invested £42.5 million in R&D, that's up 35% on prior period, and I'll share some of the specifics of this later.

Central costs were 6% up on prior year, reflecting higher accruals for performance-related employee rewards. And looking at performance in constant currency, adjusted operating profit excluding gene editing costs, was up 15%, and that's above our medium-term target of 10% CAGR growth.

Turning to volumes. Porcine volumes grew 5%, with North America a key driver at 11% growth. China returned to volume growth, up 23%, and contributed 1/5 of PIC's growth. In bovine, we achieved 4% volume growth. This was due to continued growth in sexed-genetics. And from a regional perspective, North America led the way with 24% growth in sexed-volumes.

Beef volumes were flat with Latin America a key driver of growth in prior periods. Overall, Latin America's volume was down 3% with embryo volumes particularly affected by the challenging market conditions.

As I've said before, I want to show you what happened in PIC China versus the rest of the group. In the graph on the left, you can see the adjusted operating profit trend of Genus, excluding PIC China and gene editing costs.

Solid growth of 12% was achieved in the period. Whilst the margin at 14.2% was higher than FY '21, it was 150 basis points down on prior period, and that's due to increased investments in other areas of R&D and a lower margin in our ABS business, which I'll talk more about later.

On the right-hand side of this slide, you can see what happens to PIC China's performance. The graph on the top shows the causes of period-on-period improvement in PIC China's profit from £1 million to almost £9 million. There's been good growth in royalty income, and that was achieved as customers commenced populating farms. And supply chain costs were lower due to by-product sales margin being almost £2 million higher than prior period. And that's because the average pig price was RMB 23 per kilo in the first half.

If you recall PIC's China's profits were impacted in the prior period by a onetime refund to a customer of £3.7 million. The graph in the bottom right shows the volume trends, where you can see in the first half, volume grew 23% compared with prior period, although that volume is similar to the second half of FY '22.

Upfront breeding stock sales and volume continues to be below levels seen in previous years. This is partly due to PIC's focused on growing business with customers through royalty contracts, but also the recovery of the porcine market has been very gradual.

The recent dramatic drop in the pig price to RMB 14 per kilo has created a lot of uncertainty in the porcine market. And industry expectations are that the market will start to improve in the spring. But as Stephen said, it's difficult to call. PIC delivered a strong performance, hitting a new half year record with royalty revenue up 14% and growth in royalty revenue in all the regions. Adjusted operating profit margin improved to 39.2%, although not back to the level in FY '21 when more margin was achieved in China and Europe's margin was also down a little in the period.

The changes in operating profit shown here are in constant currency as I think they give a better indicator of underlying performance across the regions. North America hit another record of growth. with operating profit up 14% on prior period as they continue to take market share and benefit from sales to Olymel.

Royalty revenue growth was also strong at 10%. Latin America's profit was up 12% with growth achieved by all countries in the region. Our joint venture with Agroceres in Brazil saw profit up 8% on prior period. Europe's profit was 5% down despite growth achieved in revenue and volumes. We've continued to achieve growth in Spain and profit was flat in Russia but other countries were challenged, in particular Germany and the U.K.

And lastly, as you've heard, China's performance had a large impact on Asia's results with overall growth of 154%. Now ABS had mixed performances in the first half. As you can see in the table on the left, there was strong revenue growth, up 23%. The shift to higher-priced sexed-genetics has continued, and this along with robust price increases, particularly in Europe and North America, meant cost inflation was recovered.

However, adjusted operating profit increased 2%. And in the chart on the right, I want to show you why this has happened. Firstly, strong profit growth was delivered by North America, Europe and Asia and I'll talk more about these regions in a moment.

However, Latin America, which has been a strong driver of growth in prior periods, suffered an 18% decline in profit in constant currency. The effects of inflation on both supply and demand in the beef and dairy markets combined with the drought conditions made it very difficult. And actually, in Brazil, beef consumption per capita dropped to its lowest level in 25 years.

ABS saw in Latin America declined in demand for genetics with volume down 3% and with higher-priced embryo volumes declining by 24%, and there was also business cost inflation that had an adverse impact.

Production costs were higher than the prior period by £1.2 million, and this is predominantly due to an under-absorption of semens draw production costs in June and July last year, which was due to a slowdown in volumes produced.

In other words, it was a manufacturing volume variance. And this primarily arose due to the IT incident temporarily impacting the software that's used across the production operations. This was resolved and therefore, not an ongoing issue.

We've talked before about ABS' digital strategy and their new associated costs, which were incurred by the business as digital platforms have been rolled out across the regions. In some cases, these investments have been made ahead of generating revenue.

Moving now to the ABS regional performances, with the profit change shown here in constant currency. North America achieved record growth of 26%. That's the highest we've achieved in more than nine years. And we've talked before about the investment made in growing the strategic account sales team to win with the large producers.

It takes time to build these relationships, and I'm absolutely delighted for the team to see the progress that has been made. This, together with growth in IntelliGen third-party business meant revenue was up 18%. Sexed volumes grew very strongly at 24%, whilst beef volumes were down 4% against a very high prior period compare.

EMEA's revenue was up 10% and profit up 8%, even though total volumes were down 2%. And that's due to really robust price increases to offset inflation. Sexcel continued to grow at 13% and beef volumes were up 6%, particularly across France, Northern Ireland and Russia. And as you heard from Stephen, IntelliGen third-party business also grew in the region.

Asia continued to achieve good growth in operating profit up 11%. China and Australia experienced double-digit growth in volumes and profits.

China is gradually shifting dairy demand to Sexcel, whilst Australia promoted Sexcel and NuEra very well. Overall, R&D increased in actual currency, £11 million to £42.5 million. And it's important to note, half of this growth reflects the impact of FX translation. The growth in spend was as planned with the largest drivers being expansion of PIC supply chain and the PRRSv program as we progress to FDA approval.

Porcine product development was up 12%, reflecting investment in digital tools for trade capture amongst other genetic developments and the increase of elite animal since Atlas Farm became fully operational.

And as you heard from Stephen, we have expanded our activities in relation to obtaining regulatory approval for the PRRS pig, including increasing our population of gene-edited pigs by over 50% in the period. And consequently, our gene editing spend was up £4 million, which is what we expected.

Bovine product development spend was stable, reflecting continued investment in IntelliGen production enhancements and our dairy and beef development programs.

Other research increased 17%, supporting the R&D pipeline, particularly in the field of reproductive biology. We consistently measure and report adjusted results as we think these give a better view of the business' underlying performance.

Our statutory results are affected by a number of noncash items, and I will talk you through these. Statutory profit before tax decreased to £15 million and profit after tax on a statutory basis was £12 million. The adjusted tax rate was 24.2%, that's down 90 basis points compared with the prior period and due to lower deferred tax charges on previously unrecognized losses.

Those of you that are familiar with our accounts will know that we are acquired in our statutory accounts to apply IAS 41, which is accounting for biological assets. The effect was a £17 million decrease, of which £15 million is due to the application of higher discount rates to the valuation of the biological assets. The discount rates simply reflect higher global interest rates.

And those of you who followed us for some time know these fair value calculations can fluctuate and are noncash movements. Exceptional expenses of £2.2 million are principally in relation to the legal costs for the ongoing litigation with STgenetics, but included within that is a credit of £900,000 being the net effect of settlement of the 987 patent and Indian patent disputes. And this is further explained in the accounts.

Finance costs were up £3.4 million. That's a 126% increase and that reflects higher interest costs on higher debt levels than prior period. Before we take a look at the movements in our net debt, I wanted to talk about free cash flow. You can see in the table on the left, our operating cash flow was £25.7 million reflecting cash conversion of 62%. This is comparable with the prior period, and I expect by June, we should reach our annual target of at least 90%.

Free cash flow was an outflow of £3 million which was a significant improvement on the prior period when it was an outflow of £16 million. The drivers of change in the cash flows are shown in the chart to the right.

What you can see is that EBITDA was up £10.5 million and spend on CapEx was £12.8 million lower than the prior period. If you recall, FY '22 was a peak year of investments in our porcine and bovine facilities.

Working capital movements was an increase in outflows of £2.6 million, which primarily reflect the timing of payables and an increase in IntelliGen equipment held in advance of delivery to our third-party customers. Good advances have been made in reducing day sales outstanding and inventory months on hand are stable.

In the prior period, we had the benefit of a onetime cash receipt of £3.6 million from a legacy legal claim in Brazil. And we are now bearing high interest and tax payments of circa £3.5 million. I expect free cash flow to improve further in the second half with growth in EBITDA and good working capital management. CapEx for the full year will be around £40 million.

You can see on this chart, we ended the half year with net debt of £214 million. Our leverage moderately increased from 1.7 to 1.8x EBITDA, and remains within our targeted range of 1x to 2x. At the 31st of December, the headroom on our credit facilities was £103 million.

With increased debt and high interest rates, I expect we will have higher finance costs in the second half and it will be up for the full year by around £8 million. This is higher than previous expectations due to higher rates and the FX translation of U.S. dollar interest into Sterling. But despite this, improved free cash flows in the second half should lead to leverage decreasing to around 1.6x EBITDA by the end of the fiscal year.

So given our solid financial position, we propose our interim dividend remains flat compared with prior period, which is 2.8x adjusted earnings cover, and that's within our targeted range of 2.5 to 3x.

Before I finish, I wanted to say on behalf of everyone at Genus that we feel very privileged to have Stephen as our CEO, and it is our pleasure to work with him. There are many reasons I say that. But the one I want to share is that Stephen is unwavering in his commitment to invest for the long term regardless of what's happening in the short term. Whether this be investing in our people, animals, research or our facilities. For all of us, that is very motivating. So we're not saying any feels just yet, we've got more to do together in the coming months.

I'll now hand over to Stephen to conclude our presentation.

[Stephen Wilson, CEO]

Okay. Well, thank you, Alison, very much, and thank you for those kind remarks at the end, particularly. Look, we've covered a lot in this presentation. So I'm just going to summarize very briefly.

I think what you can see here is we've achieved good results in the first half, both financially and in terms of strategic progress. Market and geopolitical conditions remain challenging and volatile for customers in many parts of the world. But our performance has been strong in North America, and we expect this to continue.

Think more broadly, our strong product portfolio, our depth of talent, it just gives us confidence that we're going to continue to make good strategic and financial progress. And so our overall performance expectations for FY '23 are unchanged.

So thank you for joining us, and we look forward to answering your questions in the online Q&A coming up.