Scandi Standard AB (publ)

STO:SCST

Earnings Call Transcript 2022-Q3

[Operator]

Ladies and gentlemen, hello, and welcome to the Scandi Standard Interim Report for the Third Quarter 2022. My name is Maxine, and I'll be coordinating today's call. [Operator Instructions].

I will now hand you over to your host, Jonas Tunestål, CEO, to begin. Jonas, please go ahead when you're ready.

[Jonas Tunestål, executive]

Thank you. Good morning, everyone, and welcome to this presentation of Scandi Standard's results for Q3 2022. I'm Jonas Tunestål, CEO and Managing Director of Scandi Standard. With me, I have Julia Lagerqvist, our CFO, and I'm pleased to have her by my side today to report a good quarterly result.

The next slide, please. During 2022, we have demonstrated ability to counter the ongoing strong inflation together with our suppliers and customers. I'm very pleased to report the quarter with strong earnings recovery compared to the same quarter last year.

The positive development in EBIT is driven by successful implementation of price increases, profitable growth in Ready-to-eat and high export prices. With good result, tight capital control and unusual low working capital, our cash flow was very strong in the quarter. After quarter stabilized costs, we now prepare for a period of uncertainty in terms of inflation and changing consumer behavior.

The next slide, please. Over the years, Scandi Standard has been generating substantial organic growth with stable EBIT margin of around 4% and 10% return on capital employed. In the second half of '21 and Q1 '22, we experienced a significant drop in margins mainly due to the lead time in obtaining compensation for the high cost inflation and low export prices.

From Q2 '22, we have largely managed to compensate inflation through price increases, profitable growth in Ready-to-eat and high export prices. Prices increased have partly been achieved through downward adjustments in throughput. So I'm pleased by the way our organization is working to compensate the consequential adverse effects of unit costs through efficiency measures. And during the period with lower activity level and investment, we have also taken the opportunity to strengthen our quality of production process end-to-end. And in the longer term, there is a considerable potential for increasing the value per bird processed.

It will be material for Scandi Standard to establish a long-term stable earnings level above the margins reported between 2015 and 2020. I can see that the transition requires a strong focus on the right culture, governance, leadership and increased efficiency throughput the value chain. And we also need to be innovative in our development of our product portfolio. At the same time, we will create a fundamentally sustainable business in the long term. The work with these strategic focus areas is ongoing for all Scandi Standard but change take time. And after my first quarters with Scandi Standard employees, I'm convinced that together, we can look forward to a positive and value-created journey ahead.

So next slide, please. Let's look into the input costs. The table on the top shows the massive inflation for some of our main cost items. Although feed prices have remained stable during the last month, there is still a large uncertainty in price development for key input factors.

Our Irish business has so far benefited from favorable hedging of such raw materials, but is preparing for large step-up in pricing in the new year. There is generally an expectation of high electricity prices in the coming periods and large uncertainty in the cost development related to factors such as packaging, logistics and in turn, wages. We are, therefore, preparing to implement a set of measures as required to protect our earnings. We have to be prepared for some lead times and implementation of required price increases in case of further high inflation.

Given the substantial price increase already implemented in many markets and segments, we're observing high price elasticity in the most price-sensitive consumer segments. These play out among other in higher consumer or imported goods, which is usually produced under lower standards regards to food safety, animal welfare and also antibiotic use. So we are working together with our industry organizations in our domestic markets or measures to remind consumers of the general supplier of standards of Nordic and Irish produced chicken compared to the most other origins.

The production cycle for chicken is significantly shorter than, for example, beef and pork, which has contributed to Scandi Standard being able to compensate for inflation by relatively quickly adapting our production volume to the market demand. At the same time, long lead times in beef and pork production have led to surpluses and price pressure for these proteins, which is indirectly impacted chicken consumption. When the production of beef and pork has balanced the volume to the market demand, we expect profitable volume growth for our chicken products.

Next slide, please. And if we look into our positions in our markets. So each market is well consolidated with 2 or 3 players and consumers in each market generally have a strong preference for local produce. With market-leading position in all markets but Finland, our own production adjustments have a meaningful impact to the domestic market.

The loss of supply and demand leads to a lower demand with increased prices. So we had hence, adjusted our supply accordingly. In some cases, the market leaders responsible measure has led to a temporary loss of market share. But we expect to regain these market shares up on a normalized market, which is expected once lead times in cutting supply of beef and pork is becoming effective. So ramp-up in volume will benefit our unit cost due to the fixed cost dilution.

So next slide, please. So let's look into the export market. We have seen significant further price increase in our export business during the third quarter. This is mainly driven by a reduced number of chicken in Europe. Our price achievement in the quarter has been positively impacted by less export restructuring-related to bird flu. That's related to the Asian sales. We are in the process of strengthening our export model as well, so we are focusing on strategic client relationships. We also improved sales and operations planning to get most out of each market and increased our flexibility between export and Ready-to-eat with respect to raw material.

So I'm pleased to announce that we have made a breakthrough in our efforts to reduce our exposure to such restrictions through regionalization. This will reduce our financial exposure to the bird flu going forward. This principle is already affected in Denmark, and we expect other countries to follow.

So next slide, please. This table shows the reconciliation of our segments. We see a positive contribution from all areas compared to Q3 '21. The category other includes Ingredients business, which has performed very well in the quarter due to strong price increase in pet food and MDM and biogas as well. This business secured an optimal usage of the whole world and it is a focus area both from a profitability perspective but also from a sustainability point of view.

So next slide, please. When we look into Ready-to-cook, our EBIT and Ready-to-cook is still lagging our historical performance. Our substantial price increase have partly been facilitated by temporary volume reduction. This has increased our unit cost, and we are focused on efficiency measures to mitigate this. We see scope for gradual rebuild of volumes in line with demand. As an effect of our improvement program, LTI has clearly stabilized the lower level, around 30% lower than previous year and we are now ready to take the next step in our LTIs to probably improve during the 2023.

Next slide, please. And if we look into specific Ready-to-cook Denmark, that has been challenging for us. And as you know, we have realized large losses during the last periods. The sources of the losses remain and it will take time to turn the business into profitability. The business has recently been further challenged by reduced demand in slow-growing bird products. The impact of this has partly been compensated by higher export prices.

One of the problem has been the lagging on contractual flexibility with our counterparties, which has been a barrier for implementation of price changes. It is important to obtain more balance in these contracts to the best of the long-term prospect of entire value chain in Denmark. So we are in the midst of channel change into the slow-growing bird business. Volume and price better aligned with domestic retail clients and higher flexibility in the mix between breeds and reduce costs.

But for the second consecutive quarter, the combined business, including RTE and ingredients in Denmark showed positive EBIT in the quarter, which is good from a marginal point of view. So obviously, it's crucial to develop a sustainable platform in Denmark, which has satisfaction return on capital, and I'm spending a large part of my time to facilitate this together with the local management, and we will focus on continuous improvements.

So next slide, please. Yes. And on this slide, you can see the channel development in more detail. Through these details, you can notice, the strong increase in foodservice channel in the quarter, which has been driven both by price and volume with a somewhat slower development in retail, which is due to the price elasticity in this channel.

Next slide, please. If we look into Ready-to-eat. So looking at our business in Ready-to-eat, we delivered a good performance in the quarter with net sales of SEK 802 million and an increase of 36% for the quarter, and EBIT increased by 52% to SEK 70 million during the quarter. So demand for Ready-to-eat products remained very strong, and the result is made on stable volume throughput. Provided some momentum in this part of the business, coupled with prospect of higher degree of profitability, vertical integration, we have decided to embark on a significant expansion on our capacity in Farre in Denmark.

So we planned 25% increase will allow us to take advantage of the market opportunities within the breeder segment. This segment is very price competitive and has experienced tremendous growth at the expense of beef in quick service restaurants. Following COVID, we also gained a much stronger foot haul in the retail segment for these products as well. And if we look into the LTIs, they were lower than normal in the quarter, and no critical complaints were reported.

The next slide, please. And here, you can see some examples of our products. It's typically Ready-to-eat product that we are selling to the retail market. And it's both from our Norwegian and our Finnish business and also from our Swedish business.

So next slide, please. And when we look into the channels in Ready-to-eat. It is, of course, very encouraging to see the Ready-to-eat is growing and outperforming pre-demic sales. The development is driven by increased sales in the foodservice channel. But during the quarter, we also see that RTE is growing in the retail segment. So growth in this segment will be a priority for me in the coming years. Ready-to-eat will be an important tool in development of the EBIT per sale, i.e., the increase in the value of the protein.

And with that, I hand over to Julia for more detail in the financials. So Julia.

[Julia Lagerqvist, executive]

Thank you, Jonas. If you go on to Page 15, we come back to our overall P&L. And as you've seen, the quarterly performance showed a clear improvement with the previous quarters. There were no noncomparable items booked, and EBIT landed SEK 112 million. Finance costs are increasing with a higher base rates and also a temporary increase in margins linked to new financing. All in all, net income for the period landed at SEK 66 million, far above last year, indicating an EPS of SEK 0.99 for the quarter.

Looking at the feed conversion ratio or feed efficiency, it is measured as a kilo feed needed for 1 kilo live weight, and their chicken has one of the lowest levels of animal protein at 1.5. There's been at a stable level, even slightly improving versus 2021.

Coming to Page 16, looking at return measures. We see that the declining results in the previous quarters have led to a lower level of return in capital employed to 5.2% for the last 12 months. This is, however, an improvement versus the previous quarter at a low 3.2%. And looking at the annualized returns based on Q3 results, the return on capital employed would have been above 10%. At the same time, our equity ratio has improved somewhat and is now at 31.5%, supported by our cash preservation measures.

Coming to Page 17, looking at working capital. We continue to see a low level of working capital this quarter. Inventory has increased versus the same period last year. This is mainly driven by inflation versus the year-end of 2021, we have mitigated the inflation to inventory reductions.

Payables and receivables also both continued to increase, driven by the cost and price increases. That has been targeted effort on receivables. And in addition, we've had some early payments and also some positive timing effects driven by favorable payment base suppliers. This is giving us an improvement in working capital and working capital to sales ratio is now minus 1.6%. The target levels of working capital to sales, excluding financing items, remains around 6%. At the moment, we are somewhat below this level.

Moving to the next page, we have our cash flow overview. And as Jonas has mentioned in the beginning, we reported strong operating cash flow in the quarter. EBITDA is at a solid SEK 212 million and we have the release of working capital as presented. Investments are still at an historic low level even if we have ramped up investment somewhat versus previous quarter. Paid price financing items are increasing, driven by the increased base rates as previously mentioned. But all in all, this has led to a reduction of EBIT of full SEK 216 million in the quarter.

On Page 19, you have our cash flow guidance. CapEx for 2022 is estimated to be around SEK 300 million versus SEK 306 million in 2021. We have a clear focus on facilitating further growth with Ready-to-eat, as Jonas mentioned, to meet the demand we see there. Another priority is our ERP implementation. Year-to-date September, we have invested SEK 143 million. So we plan for high investment levels in Q4. We also expect some working capital tie up.

The paid interest level is estimated to be at 6% to 6.5%, increased due to the increased base rate also on factoring solutions. And the blended tax rate is expected to be around 21%. We have, as previously reported, a new 5-year sustainability-linked financing in place since mid-Q2. And finally, our dividend policy remains unchanged at 60% earnings over time.

And final slide for me. We look at our sustainability KPIs on Page 20. As Jonas has mentioned in the beginning, we are pleased to see that LTIs, lost time injuries, has stabilized at a lower level, meaning that they are around 30% below the high levels of '21. We continue to focus on this area every day, and we will work towards further in lowering the injury rates in 2023.

However, as reported in the last quarters, we have had unacceptably high figures on our main animal welfare indicator foot pad score and also use of antibiotics. This is driven mainly by decline in the Irish performance. We have added group resources to address these issues, but lead times means that the results will only be visible during next year.

Looking at our CO2 intensive for our own operations, they continue to improve versus last year and the Q3 result is 7% below the same quarter last year. The main change in the quarter is decreased use of fossil fuels in the Swedish operations.

And with that, I hand back the word to Jonas.

[Jonas Tunestål, executive]

Thank you. Now I want to present our climate labeling. So as we communicated in the second quarter, we have together with the climate specialists the Carbon Trust calculated our carbon footprint on product level for 282 products in all our home markets. This analyze covers the full value chain from feed production all the way to the consumers' homes. Calculation methods are still evolving, and we will look forward to standardizing in this area. However, in the meantime, we believe that we have a role as a market leader to drive transparency and help consumers to make more informed decisions. This is why we will now climate label selected products in all markets. Depending on the country, labors will be available on pack in stores in Q4 or in Q1 '23.

This work has also helped us to identify many actions, improve our climate and sustainability efforts. One example is that we have initiated work to improve transparency in the value chain-related to sustainability data such as animal welfare, environment and climate. So all in all, with this data and this knowledge, we can focus on improving our own performance in this area. And the second thing is that we can present this data to our customers which will create competitive advantage for us as a company and for our products. And the third important thing is we can label this data to the consumer. And we think that this will be mandatory for other players to also present this in the future. So we're proud of this initiative.

Next slide, please. And now we are once again I'm going to show our 4 strategic pillars, and this work is one aspect that what I presented on the last slide is, one aspect of building a future-proof company. One of the pillars in the strategic framework that we have developed to take Scandi Standard to next level. And as you all know, my primary focus during the first period with Scandi Standard has been to recover measures. But in parallel, we also started to work together with the organization to develop our plans of taking Scandi Standard forward.

So apart from building a future-proof company, it is important ramping up our efficiency end to end, and it's about increasing the value of our protein. And of course, it's always started with the people. Although this will require a lot of hard work, I'm confident that we're able to gradually lift our performance over the coming years. And on the next slide, I will present some potential areas linked to this.

So next slide, please. If we look into, the first area, and that is a really important area for us, and that is to match domestic supply and demand, our S&OP process. It is vital for our industry because we can get most out of it in our domestic markets. And if you look down to the value of the whole bird that is when we have the right supply and we can value add that bird and take out the most value, both from our ingredients business and from our main cuts and increase our Ready-to-eat part, then we can increase the value of our bird end-to-end, and that comes to the next our Ready-to-eat potential. And as presented in previous slides, we have now invested in Ready-to-eat, and we will invest further to get a more integrated business and value up our protein.

But also everything starts with quality and production processes, and also mentioned in previous slides, we have had a focus on quality and production processes. And if we're going to be competitive in the future, these processes are crucial for us. And we also focus on our cross-border activities, and that is about benefits of scale in the whole group. We are in local markets, but we can also benefit by moving teams and showing and present what best looks like.

And the last thing is also the export business, and we'll talk a little bit about that, and I will talk more about it in the coming presentations, but we have a lot to gain to actually take strategic sales in our export business and actually improve our competitiveness to sell to the right market and take the right profit out of the best markets.

And we will be action-oriented, so some things will take more time and some things will be ongoing work for continuous improvement, and some things we can change more rapidly. But we will focus on these areas, and we will take action to be a stronger and better company in the future.

So to summarize this. Inflation largely compensated in the quarter, we are preparing for uncertain markets, we may see another round of inflation. We may see a changed consumer behavior. We also focus on changes in Ready-to-cook Denmark. That is underway both in short term, and we're looking into how we're going to make a big good business long term.

Q4 is seasonally a weaker quarter due to Christmas season, and volume recovery expected once lead markets are in balance. And we are focusing on increasing the value of that process over the coming years. And I'm confident that there is a good margin potential in the long term for our bird and our protein.

So with that, I wish to thank you and open up for questions.

[Operator]

[Operator Instructions] Our first question comes from Daniel Schmidt from Danske Bank.

[Daniel Schmidt, analyst]

A couple of questions then. Starting maybe with what we started out talking about in terms of market shares and oversupply of beef and pork, and you see once that normalizes that sort of your market shares will improve. But there's also been sort of recent discussions in Sweden when it comes to imported chicken gaming market share in the Swedish market. Is that what you're seeing as well?

[Jonas Tunestål, executive]

Yes. If we look at the market, we see a more price-sensitive consumer, and we have seen increased sales of imported meat. So we see the same, but we're also focusing on finding the right products and right product for the market. And it's not only about trading from different protein. It's also about within the protein, which SKUs can be affordable for the future. And then we have a good focus from our side to be price competitive and of course, the value competitive.

[Daniel Schmidt, analyst]

Yes. So what we're currently seeing is that the gap -- price gap between other proteins and chicken are -- have been shrinking. When do you see, when do you expect that price gap to normalize basically? Is that going to take another couple of quarters? Or what's your best guess?

[Jonas Tunestål, executive]

Our best guess is mid-'23. We see a decrease in production in pork, and that will normalize throughout the quarter. So I think that it will come throughout the quarters, but mid-'23, is my best guess.

[Daniel Schmidt, analyst]

And at the same time, they will experience higher sort of input cost in terms of feed prices filtering through that they need to try to sort of get some sort of cost coverage of when it comes to pricing. Is that correct as well?

[Jonas Tunestål, executive]

Yes, we see more stable feed prices, but they are on a higher level, and we now that there needs to be price increases within those proteins, otherwise there will be less production for the future. And that is the...

[Daniel Schmidt, analyst]

Right. I'm also sort of, I also realized that feed prices in itself are a little bit lower now. What I just referring to the lead time when it comes to beef and pork and the production lead time compared to the chicken production lead time. Do you catch my drift?

[Jonas Tunestål, executive]

Yes, I agree what you say. That's a longer lead time, and that's also a lead time compared to what's in the feed prices and so on.

[Daniel Schmidt, analyst]

Yes. And coming, sort of moving on then maybe to feed prices and energy prices. And looking at your table, it looks like sort of we expect feed prices to stay at this level, maybe a little bit lower than, of course, it was in Q2. If you look at how much of the cost base this corresponds to, I think you've said before that feed is around 23% and energy is around 1%. And of course, we've had a quite of a bigger jump in energy lately. But if you would update those percentages, would they be about the same still?

[Jonas Tunestål, executive]

No, we see increase. If you look at the feed prices, I will approximately say it's about 25%, maybe between 25% and 30% compared to, and the energy prices, I would estimate it for 2% to 3%, maybe up to 3%.

[Daniel Schmidt, analyst]

Yes. Okay. And is there any hedging in place when it comes to energy?

[Jonas Tunestål, executive]

Yes, we have hedging -- hedged our market in small terms. But in different variants, in different markets and of course, different energy types.

[Daniel Schmidt, analyst]

And then is it sort of -- is it reasonable to give any sort of average 20% is hedged or 30%? Or can you give any number to give us an idea?

[Jonas Tunestål, executive]

No, we're not presenting those numbers. So we don't comment on specific. That's where we are hedging. But we are some ways helps as we presented in the report, but that's due to things that we're hedged in Ireland.

[Daniel Schmidt, analyst]

Yes. All right. Good. And then maybe just moving on to what you talked about in terms of breakthrough when it comes to bird flu. If I got you right, there seems to be sort of an implementation of regionalization when it comes to bird flu in Denmark already. And is this a decision that has been taken in the EU? Or is this for the Nordics? Or how does it work?

[Jonas Tunestål, executive]

Yes. It's an EU decision. But then the national things that need to be done as well. So that's a regionalization commitment between Korea and EU, and then there are national things that need to be done. And then Denmark has come to -- that is already effective. And in Sweden, they're working on it.

[Daniel Schmidt, analyst]

Okay. And do you have any clue about sort of the lead time in Sweden before we get to where Denmark is now?

[Jonas Tunestål, executive]

No, it's hard to predict and guess, but we think it will be in the nearest future.

[Daniel Schmidt, analyst]

Okay. And then maybe just moving on to speaking about Denmark and Ready-to-cook, which, of course, has been the soft spot for a very long time and continue to be that way I think you mentioned you were not on board at that time, but I think you did mention a couple of quarters ago that you were in a situation where you had more flexibility when it comes to supply of slow growing birds and that you were able to adapt implicitly more quicker when it comes to demand. Has that changed in any way, given what you're seeing today?

[Jonas Tunestål, executive]

No, it's more like a continuous improvement that we do when it comes to those type of contracts with different suppliers and customers. So the way we're presenting today is more a way of saying that we are working with it, and we are moving forward, but we are not reached the goal. And obviously, we are not satisfied with our Ready-to-cook performance in Denmark. Therefore, we are focusing both in, as I presented in the last quarter, both in the short-term things about how we can bring this business back on track, but also long-term thing, how we're looking into what is the best thing for us to do long term in a more strategic way. And we are working on both trends.

[Daniel Schmidt, analyst]

And the management country change, is that related to the difficulties in Ready-to-cook in Denmark?

[Jonas Tunestål, executive]

No, the management change -- the management that we have today, they have actually and what we are presenting down here improved the performance in Denmark as total and now maintenance has been the temporary. So it's going back to this position, and we are hiring very competent person with long experience in the meat industry and it's from Denmark. And we think that with that experience and that domestic knowledge, we can take it to the next step.

[Daniel Schmidt, analyst]

Yes. Just coming back to what you started out by saying if I quote you correctly, you said it will be material to establish a profitability above the period pre-COVID. Do you mean a material effort to establish profitability above the level where we were between 2016 and 2020? Or could you sort of shed some more light on that?

[Jonas Tunestål, executive]

Yes, that's more expression for our long-term ambitions to grow margin. We see our...

[Daniel Schmidt, analyst]

But do you mean that it would be a material effort? Or do you see a material upside to establish profitability above the period where you were between '16 and '20?

[Jonas Tunestål, executive]

Yes. We see a material upside of doing it. But we also see, as we said in our slide, some things take longer to achieve and some things are more quick fixes, and I think that within these quarters have done a couple of things to improve in short term. And now we're looking into how can vary the bird even more long term, and we see material upside there.

[Daniel Schmidt, analyst]

All right. And just a final we -- you guide to SEK 300 million in CapEx for this year. With the capacity expansion that you announced now in Denmark, what -- could you give us a ballpark number for next year in terms of CapEx?

[Jonas Tunestål, executive]

No. We know that we will be higher than this year, but we don't comment on the coming periods. Thank you very much, Daniel.

[Operator]

Thank you. That concludes our Q&A session for today. So I'll hand over to Jonas for closing remarks.

[Jonas Tunestål, executive]

Yes, then I'll finish. We're saying thank you, everyone, and with this, we end the meeting, and hope you all have a good day. Thank you very much.

[Operator]

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.