Scandi Standard AB (publ)

STO:SCST

Earnings Call Transcript 2021-Q3

[Operator]

Hello, everyone, and thank you for your patience. Welcome to the Scandi Standard Interim Report for the Third Quarter of 2021. My name is Bethany, and I'll be coordinating this call for you today. [Operator Instructions]I will now hand the call over to Otto Drakenberg, the CEO of Scandi Standard. Otto, over to you.

[Otto Drakenberg, Interim MD & CEO]

Thank you very much, and good morning, everyone, and welcome to this presentation of Scandi Standard's quarter 3 results for 2021. As said previously, I'm Otto Drakenberg, I'm the acting CEO of Scandi Standard; and with me today, I have Julia Lagerqvist, the company's CFO.Next slide, please. During the quarter, Scandi Standard's business continued to face several challenges, which have had a negative impact on our results. Our net sales were SEK 2.6 billion, in line with previous year, while our operating income amounted to SEK 30 million compared to SEK 116 million the same period last year. The result is in line with what we recently communicated in our trading update. This negative development is driven by multiple factors. And to address them, we have, during the quarter, started a decisive implementation of a group-wide improvement program with the first priority on recovery in the short term and the next priority on positioning this business for the longer term.The Board of Directors has also announced the appointment of a new CEO, Jonas Tunestål, who, with a long-standing background in the industry, will take office during the first half of 2022. I and the Chairman of Scandi Standard, Johan Bygge, will ensure a seamless transition over to Jonas. So you may rest assured that as an interim CEO, it is my mission to continue to address the current challenges and implement the measures needed to bring this business back towards normalized earnings and with full force.Next slide, please. Scandi Standard has a history of strong top line growth with a compound growth rate of 7% and stable EBIT margins around 4% over the last 5 years. Our profitability is currently deviating materially from these historic earnings, and this is driven by 4 main factors, which I will elaborate on in the following slides. These factors are: the lead time in passing through historically high increases in feed prices; the low price realization in the export markets; the major losses in our Ready-to-cook business in Denmark; and fourthly, the impact of previously announced deviations in production and quality. I will also elaborate on the measures we're taking to address these factors in the subsequent part of the presentation.Next slide, please. The first factor affecting our performance is the cost inflation and the lead time in passing on these increases to the end customer. Our current pricing model has, during normal circumstances, served us well. But in times of rapid price increases, this leads to delay in pricing which has a severe impact on our profitability. Feed prices have increased by 16% compared to the last year and has a large impact as it accounts for 23% of the cost base of the company. Other input factors such as packaging, energy and transportation costs have also increased substantially. The delay in passing over price increases currently means that the price increases that we are experiencing in quarter 4 are not compensated for here and that we, therefore, can expect further deterioration of earnings in the fourth quarter. So we see a considerable short-term exposure to this price inflation.As part of the group-wide improvement program, there is an overriding priority across the group to obtain the necessary price increases towards our customers. It's comforting then that we have already seen some positive confirmation, which will have effect from the start of 2022, and we remain confident that we will be able to gradually pass through known cost increases during next year.Even though we are exposed to this pricing inflation in the short term, there are good arguments for poultry being better positioned in comparison to other proteins. As you can see in the lower right-hand table on this slide, poultry has a much shorter production cycle, which means that the category is hit by cost increases at an earlier stage; while on the other hand that the [ pace ] to changes is faster compared to proteins such as pork and beef. Further, poultry has a substantially lower price point compared to, example, pork -- beef and pork, which leads to positive substitution effect in an inflationary environment where customers focus more on affordable food. This means that we're confident that we will be able to revert to a more normalized situation over time.Next slide, please. The second factor hitting us is the export prices. While we predominantly produce chicken for the domestic market, we also have a dependence on the export market for managing excess volumes domestically and more importantly, to ensure profitable utilization of the whole bird.The export channel represents 7% of our total sales in Ready-to-cook. And as you can see in the graph here, there has been a drop of 15% in export prices over the last 2 years due to global oversupply as a result of COVID-19 impact on the food service channel and specific regulatory export restrictions regarding bird flu, preventing export sales several months after an outbreak. This has had a severe effect from Scandi Standard. During the last 12 months, the bird flu alone has had an estimated negative impact on EBIT of SEK 67 million, of which SEK 19 million only in the third quarter. We will, therefore, see a continued need to reduce excess volumes in our business. As a leading poultry supplier, we're also engaged in the dialogue with the relevant authorities to establish less rigid import restrictions to lower the commercial effects of potential local outbreaks in the future.Next slide, please. The third factor affecting us is our loss-making Danish Ready-to-cook business. Denmark has always been a tough market with sharp competition, low prices and high exposure to the volatile export markets. To address the low profitability in Denmark, the previous Danish Ready-to-cook management team introduced a new slow-growing bird strategy to increase differentiation and thereby increase price points in the marketplace. However, the execution of this strategy failed. Customer contracts did not sufficiently cover the production volumes nor the required price points to cover the incremental costs of the slow-growing birds. Large losses has since then been incurred. Long-term fixed volume contracts with farmers have then prevented us from rapidly adjusting bird intake to mitigate this unfavorable situation.How are we then addressing this structural problem in Denmark? Let me first say that I firmly believe in the concept of differentiation in commoditized markets such as Denmark. We have made now major changes to management locally in Denmark. We have adjusted the slow-growing bird strategy and are aligning it with major retail clients. We are reducing the product assortment and, therefore, also complexity. We have increased contractual flexibility with our suppliers. We also initiated structural cost reduction measures such as significant staff reductions. We are determined to cut the losses in the short term in Denmark and creating the right conditions for returning to profitability for our RTC business in Denmark.Next slide, please. The fourth factor affecting us has been the deviations in quality and production processes. And most of you probably are well aware of, we experienced unacceptable deviations in our facilities in Valla in Sweden. Then we initiated a group-wide investigation, emphasizing that any deviation should be acted upon immediately as of now. Today, I'm very happy to confirm that the outstanding items in Valla have now been closed, as confirmed by the authorities. The facility in Sweden was impacted by the heat wave in July.And in Ireland, operations were affected by the outbreak of COVID-19, which we informed about in the quarter 2 before. The group-wide investigation has now been integrated in the group-wide improvement program as part of our normal routines. As part of that program, we have made structural interventions in Sweden and Ireland, where we decided to temporarily reduce the intake of birds by 8% to 10% in both countries to achieve desired operational capability and stability. The reduced volume has a short-term negative impact on the operating income but will, at the same time, enable a more rapid implementation of desired operational improvements. This also entails a downsizing of staff in Sweden, primarily through temporary employments not being renewed and a redeployment of manning in Ireland.I firmly believe that these measures are necessary to consolidate our position as a leading sustainable poultry producer in the markets where we operate. Compliance with internal policies and zero tolerance for deviations is a must in order to meet the demand for tasty, healthy and climate-smart poultry products.These 4 areas that I've just gone through constitute the main drivers of the lackluster result in the third quarter and are addressed by our group-wide improvement program. Together with the Scandi Standard team and the Board of Directors, I'm confident this will tackle the current challenges and support value creation towards the company's long-term potential.Now let's look at the segments in some more detail. Next slide, please. Looking at an overview of the segment's contribution, you can see that the lion part of our current challenges are tied to Ready-to-cook, representing 3/4 of our net sales. We continue to see a good development for the Ready-to-eat business, driven by the recent food service recovery and continued strong demand in retail for these products. The segment Other includes ingredients and overhead costs, and this quarter also includes the final purchase payment relating to our Finnish business.Next slide, please. Taking a closer look at Ready-to-cook, top line was stable at an unsatisfactory margin of 0.4% during the third quarter. EBIT amounted to SEK 7 million compared to SEK 105 million in the same quarter last year, mainly due to the factors mentioned previously in this presentation. During the period, we also noted a negative development regarding lost time injuries. This was driven by the higher share of extra personnel during the outbreak of COVID-19 in Ireland in combination with an increased focus on reporting. Work safety now is an area where we're addressing all outstanding items forcefully going forward. Another key indicator for us is critical consumer complaints, and it is very satisfying to see that the complaints have been, during this period, at 0 level, in line with our targets. This also confirms that the production challenges we have experienced have not impacted product safety.Next slide, please. Looking at our Ready-to-eat business, we delivered a good performance in the quarter with sales increasing by 11%. The margin was significantly above the last 12 months and improved from the previous quarter. And the injury rate here was slightly higher versus previous year, but the complaints, the critical consumer complaints was at 0 in the quarter.Next slide, please. Behind the growth in Ready-to-eat is the rebound in the food service channel, as expected when COVID-19 restrictions are being lifted. We can also see a continued strong performance in retail, which is a sign of lasting demand increase for our Ready-to-eat products in the retail channel following the shift in consumer behavior after COVID-19. Ready-to-eat saw strong performance in all 3 markets, and to meet this increased demand, we plan to increase the capacity in our existing Danish RTE plant through optimized staffing.And with that, I would like to hand over to Julia for the review of the financials. Julia?

[Julia Lagerqvist, Chief Financial Officer]

Thank you, Otto.With that, we turn to Page 13 and overall group P&L. As you've seen, we've had a strong decline in both EBITDA and EBIT in this quarter. The finance net for the quarter was minus SEK 20 million and included a negative ForEx effect. This leads us to a net income for the period at a low SEK 4 million compared to SEK 78 million last year and an earnings per share at a disappointing SEK 0.04 per share.Moving to Page 14 and looking at the returns. You see that obviously, these challenging results have led to a large drop in return, both on return on capital employed and return on equity, where the return on capital employed is this quarter at 5.8% versus 8.8% in the previous year. However, the equity ratio is still stable and remains close to 29%.Moving to the next slide, 15. We see continued low level of working capital positively affected by the postponed tax payments related to COVID-19 state aid. This leads to our working capital to sales ratio to still be below 0%. Our target ratio adjusted for financing is to be around 6%. We're currently a bit above this.Looking then at Page 16 and the cash flow. As can be -- reduced EBITDA has a strong effect on operating cash flow. However, to meet the low results, we have, as cash preservation measures, restricted the CapEx spend in the quarter and have a low CapEx spend at SEK 31 million. And the operating cash flow for the quarter was at SEK 112 million. All in all, the net interest-bearing debt decreased in the quarter and has been stable over the last year.Looking at Page 17 and looking at our main sustainability KPIs. This is something that is at the core of our business. As Otto mentioned, lost time injuries have increased in the last [ 2 ] quarters. This is now a clear focus area with targeted actions. At the same time, you can see that CO2 emissions and also the use of antibiotics and the feed conversion is moving in the right direction. It is very encouraging to see.Finally for me, some words on the cash flow guidance. As we said, in order to create financial flexibility, the capital expenditures is now restricted to SEK 330 million roughly for the year compared to previous guidance of SEK 400 million. Interest level is estimated to be at 3% to 3.5%, and the blended effective tax rate to stay around 20%.We still have our contingent liability in the shape of the Manor Farm acquisition, where the final settlement will be paid now in Q4. And related to this, we will release a provision of SEK 26 million.In light of the temporary reduced earnings, we have taken, as we said, significant cash preservation measures. And as a part of that, the Board has also resolved not to propose a second dividend for 2021. But the overall policy for dividend remains the same, to be at 60% of net earnings over time.And with that, I hand back to you, Otto.

[Otto Drakenberg, Interim MD & CEO]

Thank you, Julia.So to conclude, Scandi Standard has been facing multiple challenges during the third quarter. And to meet these challenges, an extensive group-wide improvement program is under implementation, and it primarily focuses on obtaining the required price increases in the marketplace, implementing measures to turn around the Danish operations and further strengthening the production and quality processes.It's important to state that some of these measures will have short-term negative impact on results and that the external challenges we have seen now will not go away overnight. Hence, we expect that the quarter 4 results will deteriorate further compared to the quarter 3 level, and I'm determined to continue to drive progress against our prioritized targets. And I'm also encouraged by the fact that I have this very strong commitment from the full Scandi Standard team and my Board across all markets.The headwind impacting our business in the short term does not counter the strong prospects and earnings potential of Scandi Standard. We have a very solid market position in all the 5 countries where we operate and the products meeting the taste, nutrition, sustainable and resource efficiency required by the consumers in the future. I'm therefore confident that the actions we're taking will deliver a gradual recovery to normalized levels during 2022 and position us well for the profitable growth in the longer term.And with that, I will open up for question and answers.

[Operator]

[Operator Instructions] We have a question from Daniel Schmidt at Danske Bank.

[Daniel Schmidt, Research Analyst]

I hope you can hear me. A couple of questions from me then. Just starting with Ready-to-cook in Denmark, which, of course, has been a big drag with heavy losses throughout this year. Could you just give us what the numbers were last year and the year before that, so we just know what this used to make?

[Julia Lagerqvist, Chief Financial Officer]

This is Julia. Daniel, we have not shared those numbers. So as you can see it, we have only shared for this year. So that is not official information, unfortunately.

[Daniel Schmidt, Research Analyst]

Okay. But could you say anything about sort of this entity? Did it make money in 2019? What is reasonable? Why should we get back to breakeven now if it hasn't made money before? That's what I'm trying to ask.

[Julia Lagerqvist, Chief Financial Officer]

We don't -- still, as we said, we don't give out the historical figures, but we have made money historically.

[Otto Drakenberg, Interim MD & CEO]

And that is when we -- sorry, to interrupt. When we conclude in the statements that I have shared with you that we are, in the short term, going to cut losses and, in the longer term, going to bring Denmark into profitability, we rest on the assumption and the assessment of our strength of the plans compared to the assessment of the market. So just relying on historic -- on history is not the best way to predict the future in a business such as ours.

[Daniel Schmidt, Research Analyst]

Okay. Okay. But when you talk about a gradual recovery to normalized earnings levels in '22, that, of course, includes the plan for Denmark. And then what are you actually meaning by normalized level? Would you care to sort of give some more color on that? What is the normalized level for you guys?

[Julia Lagerqvist, Chief Financial Officer]

Normalized level for us is to be around the 4% that we have been historically. If you look at the graph that was shared on the...

[Daniel Schmidt, Research Analyst]

If you're looking at the EBIT margin, basically.

[Julia Lagerqvist, Chief Financial Officer]

Yes.

[Otto Drakenberg, Interim MD & CEO]

And do not confuse normalized earnings with the long-term desired level where we want to bring Scandi Standard. But we need to get to the desired levels in steps. And the first step is to get Scandi Standard back to what we refer to as normalized levels and with a further development of our group-wide improvement program that will be taken over by my successor. The ambition then is, of course, to take the company over time up to a desired level, which then is beyond, up -- above and beyond the normalized level that we referred to.

[Daniel Schmidt, Research Analyst]

Yes. And when you say gradual, is it your sort of ambition to have this at a run rate of 4% during '22? Is that going to be, hopefully, the end result of your plan for '22?

[Otto Drakenberg, Interim MD & CEO]

I will not want to comment on that one in this call. I will have to get back at a later point in time.

[Daniel Schmidt, Research Analyst]

All right. Okay. Good. And then moving on to the other pieces here. And you talked about the export price development as of late, and it's, I think you said, showed on the graph that it was down 15%, and it bounced up a little bit in Q3 versus Q2. Any comments on the latest development moving into Q4?

[Otto Drakenberg, Interim MD & CEO]

On the export prices, you mean?

[Daniel Schmidt, Research Analyst]

Sorry, it bounced actually from Q1 to Q2 and then down a little bit in Q3 versus Q2, yes. Has that been further deterioration? Or is it stable? Or is it moving even up?

[Otto Drakenberg, Interim MD & CEO]

Our assessment is that it is flattish.

[Daniel Schmidt, Research Analyst]

Yes. Okay. All right. And when you talk about the group costs, you mentioned that changes have been made, and there's a saving of around SEK 15 million that will be realized in '22 versus '21, if I got it right. And then you say that further savings are to be -- are planned, basically. Could you give us any indication of the magnitude?

[Otto Drakenberg, Interim MD & CEO]

Yes. The 2 items you mentioned are separate from each other. Previously in quarter 2, we announced a reorganization, which had savings effect annually of SEK 15 million. Today, I alluded to significant staff reduction in operations. That is another cost reduction measure. And I will give you a magnitude. I will not give a monetary magnitude, but we're looking at or implementing more or less as we speak now, it's been communicated this week to all involved, in the magnitude of slightly south of 200 people in the group.

[Daniel Schmidt, Research Analyst]

All right. And is that across the group? Or is that mostly the Danish operation?

[Otto Drakenberg, Interim MD & CEO]

That's affecting 2 countries predominantly, and in 1 country, we were doing so-called remanning. We are bringing personnel over from certain shifts to optimize the operations. So it's basically addressing -- or a sense from 2 countries.

[Daniel Schmidt, Research Analyst]

And is that difficult, do you think? I assume it's always difficult, but is it extra difficult? Because you said something about bringing up production in Ready-to-eat and sort of meeting that demand.

[Otto Drakenberg, Interim MD & CEO]

I think the person who says it's easy to do staffing changes is not on it. So of course, we have the deal -- we are talking about people. But in this circumstance, it is easier than you would say a normal downsizing because we are basically and mostly talking about hourly wage personnel. And that means that we are not renewing contracts for people, which is, of course, a lighter, somewhat easier way of reducing personnel than if you actually have to fire. The other advantage from a company point of view is, of course, that there are no significant severance payments included.

[Daniel Schmidt, Research Analyst]

Okay. So not even mentionable in that when you talk about severance payments.

[Otto Drakenberg, Interim MD & CEO]

Correct.

[Daniel Schmidt, Research Analyst]

Okay. So you're just terminating contracts, basically.

[Otto Drakenberg, Interim MD & CEO]

That is what we're doing this time around. But then the group-wide improvement program is designed not as a one-off and a one-shop game. We are putting in place a number of processes in a number of areas. I alluded to one previously in the communication around how we're going to ensure going forward that we have zero tolerance on compliance deviations, but we also have a process to constantly be reviewing efficiencies in our operation. So that means that we're going to review as we are coming into full compliance in all our countries. We're also going to look very closely in the coming period and coming year into efficiencies in our plants. I will not elaborate further on that now, but I want everyone to know that we are going to pursue all possible efficiencies. And that can, of course, lead to further manning adjustments.And just to close on your comment, when it comes to our plant that produces RTE products in Denmark, we are -- that production increase is predominantly being helped by optimizing staffing and staffing schedules to allow for that production increase.

[Daniel Schmidt, Research Analyst]

Okay. So apparently, a lot can be done just by scheduling in order to get more output. But the fact that you're bringing in less birds in order to be able to handle this and that you're sort of taking out contracts corresponding to 200 people, does that automatically still mean that top line will be coming down?

[Otto Drakenberg, Interim MD & CEO]

Well, the reduced line speed is done, to a large extent, to ensure that we speed up the compliance measures and making sure that all our standards, internal and external, are being adhered to rigorously. And line speed reduction -- temporary line speed reduction has then been seen as one important measure. Now as we become more and more of a mean and meaner and leaner organization, we shall, as it's needed, be able to increase the throughput in the future as it's needed because we're going to work in a more effective way.

[Daniel Schmidt, Research Analyst]

Yes. But that's more for '22?

[Otto Drakenberg, Interim MD & CEO]

Correct.

[Daniel Schmidt, Research Analyst]

Yes. And I don't know if there's any others on the line, so maybe I should -- I can find -- I can ask a final question, a more technical question. Julia, you mentioned that there will be a final settlement when it comes to Manor Farm in Q4. And at the same time, if I don't got it -- if I didn't get it wrong, you also said that there will be a release of provisions of SEK 26 million. What's going to be the net there?

[Julia Lagerqvist, Chief Financial Officer]

We haven't disclosed that in this report. But basically, what you're seeing that we had reserved a higher amount and where we finally landed, and that's why you have this positive effect of SEK 26 million.

[Daniel Schmidt, Research Analyst]

But the net effect will be less then? Again, it's going to be a one-off, so it doesn't matter. But okay, I'll step back.

[Operator]

The next question comes from Christian Nordby at Kepler.

[Christian Olsen Nordby, Equity Research Analyst]

I have a question regarding the bird flu situation. You're right that it was detected in Denmark in November 2021. What's the situation in the various countries?

[Otto Drakenberg, Interim MD & CEO]

The situation regarding bird flu is that there has been a case detected in Denmark. Now yesterday, we heard of a case detected in Norway. This was late yesterday afternoon. And the authorities work in such a way that they try to contain the situation regionally. And if you look at the Norwegian example, for instance, there is -- where the affected flock there is in the proximity of the suppliers to our operations. And that means that the affected population has been taken care of by the authorities, and that's the same case as the case found in Denmark.But it's still too early to see all the consequences that this will have. So there are one in Denmark, one in Norway. We are assessing and monitoring the situation. And of course, bird flu is not new, so it's something that the authorities and the breeders are used to, and they also have very tough protocols on how to act, not only to prevent, but also in the case that it do appear, how they shall act them. So we are confident that the authorities and the breeders are doing what they have to do, and we are monitoring the situation closely, of course.

[Christian Olsen Nordby, Equity Research Analyst]

But given that you have had bird flu for a while now, I assume we shouldn't extrapolate any further decrease in export prices. Or do you see that as a potential consequence as well?

[Otto Drakenberg, Interim MD & CEO]

I think it's too early to say. We are monitoring the situation. I referred to 2 cases which are almost happening and have happened sort of in real time. So it's too early to say.

[Operator]

[Operator Instructions] We have a question from [ Helena Wand ] at [ DI ].

[Unknown Analyst]

So I just have a few short questions. You're talking about the high prices on intake, energy and transport and that you will have to raise prices towards customers. How will you be able to do that? I mean, if you go to the grocery store now, you see a constant -- I mean, chicken is constantly on sale.

[Otto Drakenberg, Interim MD & CEO]

Well, built into our model since ages ago is the fact that any price increase from our suppliers shall be ultimately pushed through to our customers. And obviously, that's not unique for poultry. I would say that it's more or less the same for all fast-moving consumer goods categories. If you look at the track record of Scandi Standard, we have been good at that, good at passing through the input prices off to the customers and onwards then to the consumers. That's -- the latter is obviously not our choice.If we look at the current situation, you could say that as you go into a grocery store, you would find poultry being more affordable if you look at cost per protein unit. And in this particular situation where we have such steep price inflation that is hitting most suppliers of fast-moving consumer goods, my assessment is that not only will we be able -- are we able to push through and through negotiations, of course, our cost increases further to customers, but also that in relation to other sources that the consumer could choose from in the store, we will gradually come out better in that price value equation in this very particular situation we're experiencing.

[Unknown Analyst]

So you were naming lots of challenges to say the least. Will the changes -- the program you've initiated now, will that be enough? Or do you think -- can we expect more?

[Otto Drakenberg, Interim MD & CEO]

Well, I think you should always expect more from a company such as Scandi Standard. But to answer your question more specifically, the currently identified and aligned with the Board, a group-wide improvement program is sufficient to bring the company back to what we referred to in some questions about the normalized earnings, bringing Scandi Standard back to the levels where we were before 2021.However, as we progress with implementing the quite tough measures in our group-wide improvement program, as we gain traction in the various areas commercially and operationally, we will, of course, further adapt and strengthen the group-wide improvement program. And the reason I say that is this company has so much potential and so much unfree or not yet realized potential. So the program will live on and will be strengthened to the extent it takes us to the desired level. I will not tell you what the desired level is for in terms of the profitability and returns. But it shall absolutely be above and beyond what's referred to as the normalized earnings. But to get this to the first step, this group-wide improvement program is enough.

[Unknown Analyst]

Okay. So last question, you're talking about the normalized earnings 2022. Can you specify, is it -- do you see it in the first half of the year or second half? Or can you specify a quarter when you think you will be back on track?

[Otto Drakenberg, Interim MD & CEO]

We will gradually be back or get back on track, and that's as specific as I want to be today.

[Operator]

We have no further questions registered at this time. So I'll hand it back to Otto and Julia for any closing remarks.

[Otto Drakenberg, Interim MD & CEO]

Well, my only closing remark is to thank all of you who called in. And I look forward to the next quarterly call with even more people calling in. This is not the only highlight of working as a CEO. But I think this is a very important moment where [ my expertise ] area with the leadership team and the Board meets our shareholders and investors. I get a lot of energy out of this. I appreciate your questions. And you can rest assured, we are doing everything in our power to get Scandi Standard back to normalized levels and then onwards. And we are -- feel very charged to do that. Thank you very much for being with us today, and have a great Friday.

[Operator]

This concludes today's conference call. Thank you for joining. You may now disconnect your lines.