Scandi Standard AB (publ)

STO:SCST

Earnings Call Transcript 2018-Q2

[Operator]

Good morning, all, and welcome to Scandi Standard's Second Quarter 2018 Results Call. My name is Seth, and I will be coordinating your call today. I'm now going to hand it over to Leif Bergvall Hansen to begin.

[Leif Bergvall Hansen, CEO, President & MD]

Good morning, everybody, and welcome to our quarterly presentation. If you look at Page 1, I just want to focus on over the last 4 years, the way both we and group has developed, seeing an organic average annual growth rate of more than 7%, and we have seen EBITDA margins being relatively stable over the period. And if you include the Manor Farm, the growth over the period has been close to 16%. So relatively stable. In terms of the second quarter, we will obviously be talking a lot more about that later in the presentation.If you go on to Page 3 and look at the highlights for the quarter, it was a quarter with strong top line growth -- another one, I suppose, with 10% growth and well 5% in local currency. And it was all 5 geographies that contributed to this growth. EBIT were largely unchanged from the same quarter last year, coming in at SEK 90 million. We saw improvements coming through in Norway, in Ireland and in Finland. And we have seen margin pressure coming from Sweden and from Denmark, all of which we're going to talk more about later in the presentation.The net debt in the quarter increased to SEK 100 million, driven by 3 factors, and the main one was the dividend payment of SEK 118 million; unusually high CapEx, as we have talked about, SEK 138 million; and a SEK 72 million working capital release also achieved in this quarter. All together, that delivered an improvement in adjusted EPS of 26%. Going on to Page 4 and I'm going to give a little bit more flavor about how the group has developed in the quarter. We have seen higher volume and prices coming through and also some increased costs. Volume -- strong volume increase across the group. In terms of price/mix, we have seen adverse development, mainly in Sweden and also to a degree in Denmark. And that has partly been offset by positive developments in Ireland and in Finland. COGS have been witnessing some raw material cost increases, mainly on packaging and so forth, and that has been offset by efficiency gains in operation. As mentioned, some cost increases, you have seen that coming through mainly in Denmark. In terms of the country performance, we have a mixed picture. We have seen Sweden had a large impact from stock clearance during this quarter. Denmark had been impacted by large investments and costs in [ the concept ]. Norway, we have seen best-in-class margins. Strong performance in Ireland, and Finland take another significant step towards breakeven also in this quarter.Going now to Page 5, give you a little bit of a flavor about product categories and sales channels across the group. You see the sales mix changes towards the higher-value categories, with good growth in chilled, driven by volume and also by higher value per bird, mainly coming from Finland and from Ireland. We have sold out our frozen inventory in Sweden. I'll come back to that a bit later. And we are seeing yet another quarter with very strong demand and successful development within the ready-to-eat category, and that has also been supported in addition to successful launches also by investments we have done over the last couple of years in Sweden and Norway. And as we speak, the investment we do in expanding capacity in Denmark in this area is also to build a platform for further growth we have seen in this category.In terms of the sales channels. Retail increase was 7% and foodservice was 12%, also reflecting the fact that people are increasingly eating out, but also underlining that people are eating more and more chicken. We will be -- and of course, again, we will be talking more about these group breakdowns. Going on to Page 6, about Sweden. It was a quarter where we're delighted to see a clear market recovery, but also -- and a profit improvement -- a profit development that was impacted by some stock clearance. We saw 4% increase in net sales. The retail margin was 5%. And on the chilled product, the retail margin was 11%. We have seen stock build during the period where demand has been low in Sweden, and that inventory we have sold a part of during this quarter at low prices, and that actually impacted margin negatively.There is still some frozen inventories to be cleared during the second half of the year, but that doesn't change the fact that we are confident that we will return to the historical margin that was in Sweden once this is cleared. We have decided to outsource the processing of speciality birds, and that delivered a nonrecurring item in this quarter of SEK 23 million that is related to the plant closure. And we do anticipate to see positive margin effects of this initiative from 2019. Also positive to see that all trade restrictions linked to the bird flu incident has now been lifted. We saw a quarterly impact of SEK 6 million, and we do not expect any further financial impact of any significance in this -- with this regard. Going on to Denmark, a quarter with a strong focus on product differentiation and also on the expansion project. 10% revenue growth, 4% in local currency and that -- they were delivered in the main by growth in retail and also in the ready-to-eat segment. And that was the same picture as what we saw in Q1. It was quarter with reduced margins, coming from investments in supporting this new launch, so sales and marketing costs relating to that. And we also see somewhat higher raw material costs coming through in this quarter. Continue to see positive development for the new brand, De Danske Familiegårde. We are gradually strengthening our market position, and we do anticipate to see positive contribution from this range from 2019.We are about to finish this investment in expanding the capacity of our ready-to-eat manufacturing in Denmark and from that, about SEK 67 million of CapEx coming from this quarter, and we expect to start production within the next month or 2. Going on to Norway, a quarter with strong performance. 5% revenue growth and strong margins, 1% growth in local currency, which is in line with the market. We also want to remind everybody that Q2 is usually the strongest quarter in Norway. This is the most profitable geographic segment within the group. We have seen the effect of some very successful investments that we have done in Norway over the last 3, 4 years really paying off, and that's driven by a lot of best practice we transferred into Norway, particularly in the operations area. And we also are seeing clear strengthening of our product offering in Norway as part of the positive market development. And there's a good illustration of the potential within the business model.Going now to Ireland. Very strong performance, and the integration is going very well, even better than planned. We saw a 17% revenue growth, 9% in local currency; combination of a strong domestic market and also that we have strengthened our position within the Irish market. Seen margin improvements coming through this quarter, driven by 2 main factors: one is increased price realized per bird and also increased operations efficiency, better yields and better efficiency in production. Basically, we delivered through a lot of initiatives which we have expected within the group, and that has built the platform for this development. There is a number of investments defined for the Irish business: one, to deliver more cost efficiency over the years to come. There's also some debottlenecking coming from the strong growth and the growth potential we look at. And we see those projects to be gradually phased over the coming years.Going now to Finland, Page 10. It's good to see a quarter with further improvements and also another quarter where we are cash-generative, 31% revenue growth, 14% in local. And that is 7% higher revenue compared to Q1, and that's clearly ahead of the market that grew around 6% in this quarter. Another clear step towards breakeven, driven by better product mix and also better yields achieved in the production. Positive operational cash flow coming out of this quarter again, and we see continued strong focus on improved product mix and yield and also the cost of the initial operation. And we do expect a gradual margin improvement to continue for the Finnish operation.And for the income statement, I would like to hand it over to Anders.

[Anders Hägg, Chief Financial Officer]

Thank you, Leif. Well, here we are looking at the reported numbers and comparing Q2 versus last year. Obviously, a lot of the numbers are affected by the Manor Farm acquisition, and that is also the case for depreciation and amortization. We also have nonrecurring item of SEK 23 million, which Leif talked a bit about, which led to the closure of a plant slaughtering speciality birds. We have higher net financial items in the quarter, and that is mainly related to adjustment relating to contingent liabilities for the Manor Farm acquisition. And also last year, we had a positive currency effect in the quarter. Looking at the tax, the difference between last year's -- again, relating more to Q2 last year, where we had a revaluation of tax in Finland. Adjusted EPS growth driven by Manor Farm acquisition.Flipping page down to Page #12, statement of financial position. Similar story to the one we had last quarter, where this quarter is improving both versus the same period last year and also versus full year 2017. Also, equity-to-assets ratio improved from 25% to close to 28%. Moving on to next page, working capital. We had a good working capital release in the quarter, contributing about SEK 72 million to cash flow, and that is pretty much coming from all countries. And having said that, we still have a too high inventory in Sweden, so we should expect further release in the second half of the year. Working capital as a percentage of sales is going down compared to first quarter this year. It's now at 7.5%. We are driving to get that down further to 7% towards year-end. As you can see there, when we consolidate Ireland from Q3, that increased the percentage of the total working capital, and Ireland has a different -- Ireland has a higher working capital intensity.Okay. Moving on to the next page then, Page 14, where we'll see the development in cash flow and in net debt. As Leif mentioned already, net debt has increased by SEK 100 million, and that is in the quarter where we have had the working capital release then, but then a quite heavy CapEx, SEK 138 million, which is 250-plus percentage of -- 250% of depreciation, and we also paid a dividend of SEK 118 million in the quarter. Then flipping the page to Page 15, cash flow guidance. No change versus what we said last time. Dividend policy is still 60% of net income over time. The cash flow estimates, we still expect the CapEx to come in on SEK 350 million for the full year. So having done SEK 228 million year-to-date, we would expect second half to be somewhere around SEK 120 million, SEK 125 million. Paid interest, one should expect to be around 3% to 3.5% of average net interest-bearing debt. And the effective tax rate should be somewhere between 20%, 21%. Again, we're just reminding you about the contingent liabilities relating to the Manor Farm acquisition, with 3 earn-out tranches, which are payable in '19, '20 and '21. And there are more details for that in the appendix. So with that, back to you, Leif.

[Leif Bergvall Hansen, CEO, President & MD]

Thank you. Just -- turning to next page, just to remind you on our sustainability template, a lot of initiatives are taking place across the group structured in the way you see here. And I'll just draw your attention to one important area, which is a strong focus on improving the feed conversion. In other words, that the birds eat relatively less feed. And we can just see, over the last 12 months, we have improved that 0.01, that ratio. And that alone had an impact where we basically used 100 truckloads less feed to produce the same amount of meat, which kind of just underlines the importance of such -- of working on such a parameter. Going on to Page 17 for summary and outlook for this quarter.So far, very strong performance both in Norway and also in Ireland. We saw a situation where both segments demonstrate the combination of a strong market position and also improved processing efficiency in core areas. So improvements continuing in Finland across a number of areas, and we are confident that we will continue a stepwise path towards breakeven. Happy to see promising market recovery coming through in Sweden. However, we have some stock build that we need to clear that are impacting profitability in the short term. But we are confident in the medium-term reinstatement of historical margins in the Swedish market.The brand name initiative in Denmark is received well to transfer the De Danske business to a bit more differentiation commodity, taking stock higher, and we see that strengthening our market position and deliver a margin potential over time. I think everybody noticed that we have had a pretty warm summer, and that's likely to impact our raw material prices, and we aim to recover these costs through cost increases over the coming periods. We expect a strong cash flow in the second half of the year, driven by working capital release as well also some lower CapEx. And not least, but based on the fact that we have seen a very successful development in the Irish acquisition, we are continuing to follow some structural opportunities across Europe closely.With that, we would like to take any type of questions. Thank you.

[Operator]

[Operator Instructions] And today's first question comes from Tone Hanstad from DNB Markets.

[Tone Bjørnstad Hanstad, Analyst]

I have a couple of questions. First, you are saying that the Swedish market is impacted by stock clearance and that there are still large frozen inventories to be cleared in the second half of the year. And could you give some more comments on how this will impact your sales and cash flow in the third and the fourth quarter? That's the first question. And the second question is -- and if you could give some more comments on how the effects of warm summer will impact the raw material prices obviously with -- and by how much?

[Leif Bergvall Hansen, CEO, President & MD]

All right. Thank you. Sorry, the line was not absolutely clear. But I think, if I heard it correct, the first question relates to the stock clearance situation in Sweden. And we have cleared a portion of this stock build that we have had. As you are aware, we have had a period where the demand in Sweden has been soft. And that has led to build of frozen inventory, and we have now -- and we are now starting, as the market is coming back, to sell this excess frozen inventory. That has given us a loss in Q2. And we anticipate that, that will also have an impact in the coming couple of quarters, but then we should have cleared that stock build. And that will add of course, a positive working capital component to release the stock during the second half of the year. In terms of feed, we are not sort of coming out with exactly what magnitude of price increase that will be required. We are obviously following this situation very closely. We are not directly impacted by this as it is our farmers who are impacted. But we are, obviously, committed to implementing the price increases necessary to reflect the fact that the harvest has been historically poor in this part of the world. One has to keep in mind that chickens are the most efficient animal in terms of transferring meat -- feed into meat, which means that when feed prices are going up, relatively, the increases in chicken prices are likely to be lower than other meats over time.

[Operator]

The next question comes from Alexandra Barganowski from Nordea.

[Alexandra Barganowski, Analyst]

Yes. I have a question on your provision in the Irish region. Just if you look a little bit more long term, what sort of margins can we expect from those 2 regions, particularly perhaps from Finland, since you're sort of on the journey to become profitable; but also in Ireland since you are expecting some improvement in that region.

[Leif Bergvall Hansen, CEO, President & MD]

Yes, if we start with Ireland. We have seen strong growth coming through. I think that is an unusually high growth. We have done well in terms of improving the product mix and through that, delivering higher value per bird. And we saw a market increase in this quarter. And we do see a number of further initiatives that will improve margins in Ireland, but we have not given any sort of specific guidance in terms of what we see as future market levels, apart from when you look over time, around a 6% EBIT is an area that has been sort of achievable in an Irish context. So we see a lot of solid initiatives taking place in Ireland. And we do anticipate to be able to take further steps to improve the position further. In terms of Finland, we are now very close to black EBIT, and we are not giving an exact timing for it, but that shouldn't be too far away. In terms of the ambition for Finland, we have said that we anticipate to deliver group average margins in Finland over time. And that is unchanged. That's still what we believe we will be able to achieve. The Finnish market remains an attractive market growth-wise, market-wise, product mix-wise and so forth. So we are confident that we will get to that level, but obviously, it will take some time.

[Alexandra Barganowski, Analyst]

And so I have a question on the sort of potential acquisitions that you're looking at. Are there any particular markets that you're looking at that you see are familiar to the ones that you're already in? Or are you targeting very different markets, say, is it more like Benelux countries? Or is it more Eastern Europe?

[Leif Bergvall Hansen, CEO, President & MD]

Well, we are looking at a number of alternatives. One has to bear in mind that there does need to be an adjacent border to any other of our domestic markets, so to speak. The synergies of being part of the group is more related to the transfer of best practice. So we are much more focused on the market position of these companies, the strength they have in the market, the product offering, the client positions and the potential to improve through the transfer of best practice rather than a specific geography or a specific country. So we are looking at a number. We have got nothing sort of more specific to say at this stage.

[Operator]

The next question comes from Mikael Löfdahl from Carnegie.

[Mikael Löfdahl, Research Analyst]

A couple of questions from me. First, in Sweden or potentially in Denmark as well, where you hope to push your increased cost in terms of price increases, how confident are you that you're able to do so? How price-competitive are you? And what is -- yes, how confident are you in that?

[Leif Bergvall Hansen, CEO, President & MD]

Yes, you could say that this is poor harvest or -- and the effect of the warm summer is something that is well accepted by everybody in the market. And we -- which is also why we anticipate that this will be possible to transfer this raw material inflation to the consumer also in the 2 markets that you mentioned because it is pretty obvious that there is a need to do so. And also, one has to keep in mind, as mentioned, that the feed conversion ratio of chickens is very, very good. So the relative increase in meat is relatively lower to what you would expect over time for competing meat, price of meat.

[Mikael Löfdahl, Research Analyst]

Yes, sure. But you don't really control the end markets here, the consumers. And also, given that there's probably going to be an oversupply of red meat in the market from local producers in the next couple of quarters and also the fact that you are reducing inventory of frozen chicken, which implies that the price of frozen chickens for consumers are still rather low, so I'm just curious on that equation if you'll be able to raise prices on chilled products while there's a price decrease on frozen and potentially on red meat as well as an alternative to chicken.

[Leif Bergvall Hansen, CEO, President & MD]

Yes, in terms of the price developing on red meat, I mean, there are some people talking about additional cattle meat being slaughtered over the coming period. I'm not sure that will have a significant impact, and particularly not longer term have an impact. You're right in saying that there is still a frozen inventory to be cleared, and that will have an impact on our performance in Sweden for a couple of quarters. But coming through that, we do anticipate that, that stock clearance is -- will take place and it will be short term in terms of impact on earnings. You're right in saying that there is always an uncertainty whether our clients will accept the feed indication on what will be the cost for the birds going forward, but we will do as much as we can to ensure that there is an alignment between the level of price increase and the timing of the price increase. But you're right in saying that there could be some short-term pacing relating to that, but we do anticipate that there is good acceptance of the need to adjust certain prices because of this drought.

[Mikael Löfdahl, Research Analyst]

Okay. Another thing then, the outsourcing of the processing of speciality birds at the [ Kronfågel ] plant. What is the margin impact? Can you more quantify that? And also, you said that it's expected from 2019, but you take the charge now. So what about the second half of '18?

[Leif Bergvall Hansen, CEO, President & MD]

That might be -- it's a small impact towards the end of the year, but we haven't given any specific number for what will be the savings. But this is -- there's a good return on this decision. So -- and we are confident that we will see an improvement from the beginning of the year next year, and there might even be a little bit of an upside towards the end of the year. But that is clearly positive.

[Mikael Löfdahl, Research Analyst]

But you can't quantify the margin impact?

[Leif Bergvall Hansen, CEO, President & MD]

No, we haven't done so. Of course, we have a number that we anticipate, but we have not communicated that into the call. So -- well, I can't really give it here either.

[Mikael Löfdahl, Research Analyst]

Okay. And then another margin impact then from the ready-to-eat plant in Denmark, which will then be up and running now soon. Can you quantify that effect on your profitability?

[Leif Bergvall Hansen, CEO, President & MD]

Well, it is a significant capacity expansion, and we are working on getting additional clients to sell this product that we now have capacity to serve. And that we anticipate to develop over the next couple of years. So we will be filling this additional production line. It is soon going to be up and running. We have talked to a number of clients to improve sales, but we haven't been giving any information about exactly when do we see these clients coming onboard. But it is clearly so that this area is relatively more profitable compared to, let's say, the meat production we have in Denmark. So we do anticipate that this will over time -- will have a positive impact to the margin and also will imply a more stable marketing development over time. In terms of the profitability that one should expect from the Danish business, what we are sort of delivering sort of into the past historically is that one should sort of expect over time to see EBIT margins in the level of 4% to 5%. In this quarter, we are lower at 3.2%, relating to sort of these investments in the new concept that we are putting through at the moment.

[Mikael Löfdahl, Research Analyst]

Okay. And final question from me. On the net financials, could you perhaps strip out the different components here and give us some sort of guidance going forward? I mean, it's quite high and doesn't really add up if you just look at interest rates that you are paying. So could you strip out the contingent liabilities, for instance, here?

[Anders Hägg, Chief Financial Officer]

Yes, the effect of the adjustments relating to the contingent liabilities is SEK 11 million in this quarter. The effect of that going forward should rather be somewhere between SEK 3 million and SEK 4 million. That will take you back to the 3% to 3.5% of net interest-bearing debt guidance that we have. So if you adjust for those, SEK 11 million.

[Mikael Löfdahl, Research Analyst]

Okay. So you mean, as of Q3, it should be around SEK 3 million to SEK 4 million rather?

[Anders Hägg, Chief Financial Officer]

Yes.

[Operator]

[Operator Instructions] So we have no further questions. I'll hand the call back to Leif.

[Leif Bergvall Hansen, CEO, President & MD]

All right. Thank you, everybody, thanks for the good questions, and have a good day. Bye-bye.

[Operator]

This concludes today's call. Thank you all for dialing in, and we hope you enjoy the rest of your day.