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Edited Transcript of AAC.AX earnings conference call or presentation 21-May-19 11:00pm GMT

Full Year 2019 Australian Agricultural Company Ltd Earnings Call

Queensland Jun 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Australian Agricultural Company Ltd earnings conference call or presentation Tuesday, May 21, 2019 at 11:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Hugh Killen

Australian Agricultural Company Limited - MD, CEO & Director

* Nigel Simonsz

Australian Agricultural Company Limited - CFO

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Conference Call Participants

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* Jonathan Snape

Bell Potter Securities Limited, Research Division - Senior Industrials Analyst

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Presentation

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Operator [1]

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Thank you for standing by, and welcome to the Australian Agricultural Company 2019 Full Year Results Conference Call. (Operator Instructions)

I would now like to hand the conference over to Mr. Hugh Killen, Managing Director and CEO. Please go ahead.

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Hugh Killen, Australian Agricultural Company Limited - MD, CEO & Director [2]

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Good morning, everyone. Thank you for joining us to go over our FY '19 results. I'm Hugh Killen, AACo's CEO. And with me today is Nigel Simonsz, our Chief Financial Officer.

I'm pleased to report continued progress on our overall branded beef strategy over the last 12 months, and I will also be outlining some of the unprecedented challenges we faced over the last 12 months, along with the rest of regional Australia. Amongst these results, you'll see the benefit of some tough decisions we made last year. Nigel will run through the detailed financials shortly.

By a way of introduction, let me say that I am more confident than ever that we're on the right path and that we are making progress despite the challenges that we face. And after the presentation, we'll take any questions. So let's move now to our year-end review, which begins on Slide #6.

As I mentioned, you can see both positives and challenges over the year just gone. Over the last 12 months, we've strengthened our unique ability to produce quality beef at scale. This has allowed our branded beef rollout to progress despite both drought and flood. We launched in Dubai in October. We're seeing strong growth across key international markets, and we've established our U.S. commercial office in Los Angeles to execute a new approach to growth beyond the 200 U.S. restaurants, which currently serve AACo beef.

I'm delighted to have brought in Chief Commercial Officer Andrew O'Brien in January year, which means our full executive team is now in place. Together, they are in advanced planning to realize our transition from a pastoral business to a fully global branded beef business.

Now despite drought and flood, the teams have achieved a 3% growth in wagyu numbers for the year. Now, this is a remarkable achievement, which speaks to the capability we have built. And this capability positions us to deliver the highest quality product around the world and under our own brand.

Now this time last year, I announced some tough decisions. We closed Livingstone Beef and our 1824 supply chain. These were and remain the right decisions for the future of our business. In the short term, we've removed $7.4 million in losses from Livingstone, and we've retained the -- and had we retained the 1824 supply chain, our exposure to seasonal conditions would have been materially worse this year. Now separate to these points but worth noting is a 5.8% improvement in the value of our overall land assets.

Now let me turn to our financial highlights on Slide #7. In FY '19, we delivered an underlying profit of $23.7 million. This is a $37.2 million improvement on the previous year, and this improvement was despite $60.4 million of additional costs as a result of extreme seasonal drought conditions. Our overall revenue is down from last year, but this is a result of transitioning away from Livingstone and the 1824 supply chain, which has allowed us to focus on strengthening our branded beef offering, including underlying wagyu meat sales, which have improved 4.5% across the year.

Our statutory EBITDA was a loss of $182.7 million. This was substantially determined by $204.9 million noncash reduction in livestock values. This revaluation is primarily driven by a decrease in our non-wagyu herd. This decrease was a combination of increased cattle sales and reduced cattle purchases. These decisions are a result of our Livingstone and 1824 decisions as well as some drought-related, non-wagyu cattle sales. In addition, the [rate] remaining variance reflects fluctuations in live wagyu market prices and write-off of stock in the Gulf. I'll mention again, within those numbers is the 3% increase in our wagyu herd, which is significant for our plans going forward.

Now we finish the year with substantial asset headroom in our debt covenants. Our gearing ratio is 29.97% is well within our target range. And on a further positive note, our net operating cash flow increased by $52.9 million for the year.

We'll move on to Slide 8 now and drill down into the major challenges we have faced over the year from flooding in the Gulf and the drought conditions more broadly. We have faced some massive challenges over last 12 months. Across the north, we have faced combined drought and flooding at absolutely unprecedented levels.

In the Gulf, we saw 500 millimeters of rain in just a few days. Some have estimated this is once in a century event. Either way, the flood was big enough to be seen from space. On the ground, we saw 800,000 hectares impacted across 4 of our properties. Now obviously, we prepare for flood events, but nothing on this scale.

The impact on our animals, staff and our neighbors was absolutely devastating. And having said that, my team responded incredibly well. We worked together with our neighbors and the communities over the Gulf country, and we'll all be stronger because of it. And thankfully, no people lost their lives in the flood.

In the final analysis, we estimate losses of 43,000 head of our cattle in the flood. This includes animals lost in the flood itself and animals lost to wind and rain exposure. The majority of the cattle we lost were non-wagyu graded. These are a vital part of our operation. However, given our scale and diversification, these losses will be managed without any impact on our ability to meet our short-term supply obligations, and our branded beef strategy roll-out will continue according to plan.

It's important to remember that, in total, our neighbors lost significantly more animals than we did and many lost a far high proportion of the individual herds. The rebuild has begun, and the region will come out stronger. Now our rebuild is also underway. We anticipate rebuild costs of around $6 million to $8 million. This will primarily include property, fences and water infrastructure. And of course, this presents an opportunity to rebuild better and stronger infrastructure drawing on some of the lessons that we have learned.

Moving now from flood to drought. Drought conditions in Queensland and Northern Territory have weighed heavily on our numbers for FY '19. We have continued to invest in growing our wagyu herd, and this has generated $60 million of costs across feeding and transport, but this is an essential investment for the future. We continue to see rising global demand for Australian beef. Together with our brand strategy, we expect to benefit significantly from this investment.

We will get to the financial figures in more detail soon, but let me say briefly that, excluding the Gulf flood, we've achieved positive underlying profit and cash flow for FY '19. This is including the additional investments outlined above through difficult seasonal drought conditions. And excluding the Gulf flood and drought impacts together, we've achieved a significant underlying operating profit. I think this is a powerful indicator that we're on the right path and that we're making good progress.

Moving now to Slide 9. As you can see on Slide 9, the Gulf flood was unprecedented in its scale and devastation. This was a large area, visible from space. Our impacted properties are right in the middle of it. At the widest point, the flood zone was 80 kilometers across. The speed and scale of this rainfall meant there was very little we could do.

We have annual flood mitigation measures in place. These include moving stock and stockpiling fuel and fodder. We built flood refuges modeled on the largest flood previously recorded, and we immediately activated our crisis management plans, including making sure our people on station were supported.

In the aftermath, we are reviewing these measures to learn for the future, reexamining -- examining how we handle stock and feed in high-risk areas, and we're also reviewing our station business model. These lessons will be important as we face ongoing seasonal and weather changes.

Turning now to Slide 10. AACo's branded beef strategy remains critical to returning lasting value to our investors. Our unique brands allow us to connect with the highest-value, highest-margin customers around the world. This allows us to leverage our substantial assets for maximum return, and this strategy is supported by increases in our elite herd numbers over the last 12 months. And we have managed to insulate this strategy from drought and flood impacts.

Turning now to Slide 11. We are continuing to command premium prices across our Westholme and Wylarah products, and prices have increased on 60% of cuts across these 2 brands. More than anything else, this demonstrates the price power and customer connection of these brands. Overall, Westholme and Wylarah revenue is up 6% on last year. And our heritage full-blood wagyu brands are up 41% over the same period. It's still early days, but these are positive signs for our strategic direction and progress.

Now these results transitioned to positive revenue growth across different regional markets. We've seen 26% revenue growth for these brands across Asia, 10% revenue growth in Australia and a 6% revenue growth in the EU. Our approach to the U.S. market is in transition. The U.S. is a global gateway for luxury products. Much of the world [takes its leap] from luxury consumption in the U.S. We're establishing a deep presence in that market as a platform for driving our luxury lines around the world. And to support this, we set up our commercial and trade marketing hub in Los Angeles.

This in-market presence will be crucial as we establish our luxury brands there. And this will form the basis of future approaches to other markets around the world. In Asia, our Singapore and Taiwan presence has been very positive. This highlights the important evolution of Asian consumers. They are discerning, affluent and seeking quality beef in higher volumes. Our strategy will continue to position us to benefit from this significant trend.

Turning to Slide 12. As I mentioned, we launched Westholme in Dubai in October. The reception was very positive. Revenue in the second half is up 49% compared to the first half of the year. We are on menu at At.mosphere, the world's tallest restaurant and recognized as the finest dining establishment in Dubai. And social media engagement in the region has exploded on the back of our launch. Our branding and marketing strategy is the right strategy for the future of our business. And as you can see, we are making progress on that strategy right around the world.

We'll now move to more detail on the financial results, and I'll hand over to our CFO, Nigel Simonsz.

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Nigel Simonsz, Australian Agricultural Company Limited - CFO [3]

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Thank you, Hugh, and good morning, everyone.

Just turning to Slide 15. As Hugh had mentioned, our results for the period reflect some key elements: our focus on brand, further building and development of our organizational capability and leadership and the benefits of the actions we have taken around simplifying the business regarding Livingstone and the 1824 supply chain during this period of extreme seasonal impacts. As Hugh has also mentioned earlier, these seasonal impacts have affected the business by $107 million in the FY 2019 year. This includes the $47 million loss due to the Gulf flood event and $60 million in additional drought-related costs, mainly for feed and transport.

And as we move into discussing further our operating results, I'd like to restate that we refer to operating profit as a key profit indicator used to monitor and manage the company. It eliminates the potential distraction of unrealized livestock valuation movements, and we believe it is a better reflection of performance.

If we exclude the Gulf loss impact, our underlying operating profit has grown by $37.2 million over the prior comparative period. This saw us finish at $23.7 million profit for the year. The decision to suspend Livingstone has contributed $7.4 million to this improvement. And if we exclude Livingstone, our underlying operating profit has improved by nearly $30 million to finish the year at $39.6 million. And this result was achieved in the face of very challenging conditions, as Hugh has already mentioned. And to reiterate, this result includes the additional $60 million in drought-related costs versus the prior comparative period.

Notably, as referred to earlier, underlying wagyu meat sales, which exclude Livingstone and 1824 revenues, have grown by 4.5% over the prior year. Westholme and Wylarah brands are gaining momentum, which includes price improvements realized on over 60% of our Westholme and Wylarah-branded cuts. And as referred to already, the challenging drought conditions have meant an additional cost of $60 million. This is mainly constituted by costs of feeding and transport to protect our core asset, being our wagyu herd. And as noted earlier, we have also increased numbers in this critical herd by 3% year-on-year.

And again, as Hugh has mentioned, this $60 million in additional cost is related to our strategic decision to further invest and grow our herd. This is at a time when many competitors were not able to do the same, and we believe this provides us with a strategic advantage as we move forward and unlock value through our premium brand-led strategy.

Offsetting this $60 million in additional drought-related costs is $20 million in OpEx savings realized from the suspension of Livingstone and the 1824 supply chain. Corporate expenses have increased as we continue to enhance support structures to see us through the next stage of our brand strategy, and these effectively relate to investments in our IT support services, the establishment of key senior roles and the opening of a U.S. commercial office.

Our statutory EBITDA loss of $182.7 million versus the prior comparable period of a $35.3 million loss is driven by the $205 million reduction in our livestock values. This $205 million decline is significant, but it is very important to note that $138 million of this has occurred in our non-wagyu herd. Declines in non-wagyu herd numbers primarily come from increased cattle sales and a drop in capital purchases off the back of the Livingstone and 1824 decisions.

We've also increased sales of these non-wagyu animals in response to drought conditions. This has also allowed us to better focus our resources on our wagyu cattle, which are at the heart of our premium-branded beef strategy. Tragically, around 41,000 head of non-wagyu cattle were lost in the Gulf flood event that occurred in February. And in addition, we lost approximately 2,000 wagyu animals during the Gulf flood.

The financial impact of this loss is non-wagyu animals is for $42 million, with approximately another $3 million in wagyu animals lost for a total of $46 million in approximate terms. Combined, non-wagyu herd count reductions represented an overall $108 million decline of that $205 million in our livestock balances. The market price for these composite animals also declined during the year, which contributed a $30 million unrealized loss to the statutory results.

Remaining declines in our livestock balance primarily relate to the valuation of our wagyu cattle. Market prices for wagyu cattle have continued to decrease from their highs a couple of years ago. And this has resulted in a $64 million unrealized loss in the FY '19 results, with the majority of this movement captured in half 1. In fact, that was over 80% of the movement occurred in half 1. And this decline in the live cattle price of wagyu does seem significant, but we remain undeterred by this as our prized wagyu are not sold live, rather, as I mentioned, these animals are at the heart of our branded-beef strategy. And as our strategy continues to gain traction, it's important to remember the declining live cattle prices effectively translate into potentially lower input costs. This, in turn, offers the potential for higher margins to be delivered by our premium brands.

Our balance sheet remained strong with $841 million in net tangible assets and significant headroom in our debt facilities. We have also achieved a $52.9 million improvement in net operating cash flows from pcp despite those extreme seasonal impacts.

Now turning to Slide 16 and cost of production. We have restated our cost of production measures to remove the impact of attrition from kilograms produced. We believe this is a better way to analyze our supply chain's production efficiency, and attrition is separately disclosed in our financial statements. As you can see, the $60 million in additional OpEx incurred in protecting our wagyu assets explains nearly the entire variance from the prior 2 years. Removing the additional OpEx seen in FY '19 due to the drought, cost of production as a whole has stayed relatively flat at approximately $1.97 to $2 per liveweight kilogram produced.

It's important to note here that our production mix has also proportionately shifted towards wagyu kilograms over the past several years. And in 2019, more wagyu kilos were produced during the year than non-wagyu for the first time in our history. In fact, in 2019, we produced 30% more wagyu kilos than we did in 2017. This is important because producing a wagyu kilo is much more expensive than producing a non-wagyu kilogram. And despite achieving increased production of our more expensive wagyu kilograms, we've managed to hold our cost of production flat, which clearly demonstrates production efficiency gains we've made across both our wagyu and non-wagyu production.

The impact of the season has been a challenge for our efforts to increase wagyu kilograms produced over the past several years, but this work means we're well positioned to meet sales demand as we enter new markets. And we'll be able to meet the demand of our branded beef strategy, which is fundamental to improving our margins and returns.

And now turning to Slide 17 and cash flow. Positively, on Slide 17, we see our cash flows have improved, with net operating cash flows seeing a $53 million improvement. This improvement is largely due to the decline in cattle purchase requirements and the increase in cull and composite sales and also in the context of the extreme seasonal conditions we've experienced.

And now turning to Slide 18 and balance sheet. On Slide 18, you will see that our balance sheet remained strong with a $1.3 billion asset portfolio and $841 million in net tangible assets. The statutory reductions in livestock values has had a minimal impact on our LVR ratios, and we continue to enjoy substantial asset value headroom remaining on our debt covenants.

We also finished the period with a gearing ratio of just under 30%, which is well within our target range. Our borrowings have increased only marginally during the year by $13 million and therefore increases in the gearing ratio and declines in NTA are largely associated with the result of the decline in livestock value held on the balance sheet partially offset by improvements in our property values.

And with that, I'll now hand back to Hugh.

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Hugh Killen, Australian Agricultural Company Limited - MD, CEO & Director [4]

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Thanks, Nigel. We move now to Slide 21 on sustainability. At the half year, I talked about our commitment to sustainability. I outlined our focus on implementing leading practices across all of our operations, and in the last 6 months, we've made important progress. This includes finalizing and releasing our first sustainability policy, and this is being signed by the Chair and I and is available online. This policy will guide decision making across our business into the future.

The first paragraph in this slide is the first paragraph of our policy. As you can see, we want to be a leader in sustainable beef production, and this includes a couple of elements: always striving for best practice and continuous improvement in management of the environment and animals under our stewardship, minimizing any adverse impacts from our operations and contributing positively to the communities where we operate.

Responsible business is good business. We have responsibility to our environment and our animals across their life. The principles in our policy reflect these responsibilities and guide decision making at every level of our business. As well as being the right thing to do, this commitment is a nonnegotiable for our customers. And being proactive will position us to address the narrative, which is emerging about beef production and our impact on the environment.

We'll assess our progress and report back annually. We want this public accountability to be embedded in our annual planning and review. You will see a number of focus areas identified in the document. Our reporting will detail progress and lessons learned across these, and I encourage you all to visit our website and have a look.

Now moving to Slide 24, our strategy. As you can see, our strategy and strategic focus remains consistent with my report 12 months ago.

Turning to Slides 25 and 26. We outlined our progress over the last 12 months. Innovation is core to our progress against this strategy. This has driven key investments and partnerships, which we have entered into to drive our business. These partnerships and investments are always guided by 2 objectives: accessing cutting-edge skills and services where we need them, and creating value through the innovations, which drive our business.

By way of example, this approach has been central to our work in capturing and utilizing generic data on feed conversion and animal health. We're also focusing driving the right performance culture across AACo. We now have our full executive team in place. We have a fully embedded performance framework, and I now expect to see accelerated activities during each of our -- driving each of our strategic priorities over the coming year. And of course, safety and welfare remains our #1 priority, and this will be central to leadership development at all levels of our business.

Moving to our current operating environment on Slide 28, and I'll move fairly quickly through these next couple of slides. I want to spend some time on our operating environment and the conditions likely to impact us over the coming year. You can see the impact of drier conditions on our cost and bottom line over the last 12 months. We expect these conditions to create continued upward pressure on station operating expenses, in particular, feed and transport costs, and we would expect to see continued strong cattle sales across the industry.

Turning to Slide 29. You can see increased demand for Australian beef exports. These are growing year-on-year, and the low Australian dollar suggests this trend should continue. At the same time, drought conditions have reduced average carcass weights across Australia. Meat & Livestock Australia have predicted this trend to continue. They are expecting something like a 3% drop in production this year as a result.

Slide 30 provides additional detail on global beef demand. Generally, demand is increasing as supply is increasing alongside it. But in Australia, global demand is rising for our products even as production is decreasing on the back of tougher seasonal conditions. In this context, our growing wagyu herd and branded beef strategy positions us to really benefit from this positive global trend. Again, I think this underscores that we're on the right track and must continue to make progress on our strategy.

We want to continue to benefit from what's happening globally and into the future. This means really focusing on changes in global consumer trends over the coming 12 months. We know these trends include a focus on sustainability and animal welfare. This is core business for us anyway, but our consumers will reinforce this commitment. We're also likely to see growth in the digital component of consumer engagement. Some predictions suggest half of all luxury purchases will be digitally enabled by 2025. This means having the right technologies driving and complementing every part of our value chain.

We're also seeing growing influence of young consumers. These consumers are driving demand for a full dining experience, capturing every part of our product, our story and the impact of our production systems. AACo's remarkable assets uniquely position us to deliver the highest quality beef on a truly global scale. Our global branded beef strategy means we can engage directly with consumers all over the world. Together, this means we are capturing and will continue to capture the benefit of these global trends. Now this is the right path to creating lasting value for our investors, and we have the team in place to continue driving AACo's progress.

Thank you for everyone's attention. And Nigel and I are happy now to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question today comes from Jonathan Snape with Bell Potter.

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Jonathan Snape, Bell Potter Securities Limited, Research Division - Senior Industrials Analyst [2]

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Look, just one quick question. I'm looking at -- I think it's note A3 at the feedlot cattle number and the closing kind of head, it looks like it's down 14% year-on-year. I know you've given some guidance around costs. But how are you kind of thinking around the production volumes the next year in light of that?

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Hugh Killen, Australian Agricultural Company Limited - MD, CEO & Director [3]

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Jonathan, as I said in the prepared statements, we don't see any impact on production volumes from the flood event. And we are -- we have been investing in our overall wagyu herd numbers. So I don't see any impact in terms of production at all into the -- meeting our supply agreement next year at all.

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Jonathan Snape, Bell Potter Securities Limited, Research Division - Senior Industrials Analyst [4]

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Okay. But in terms of looking at the sales volumes next year, second half was kind of consistent with the first half. The inductions looks like they were down. I mean, how are you thinking in terms of sales evolving through the year? Are we're kind of looking like a number like this year in the luxury and prestige? Or is it likely to come back a bit?

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Hugh Killen, Australian Agricultural Company Limited - MD, CEO & Director [5]

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Look, Jon, without getting too forward-looking in my statements, I think, we're seeing strong demand for our products, and we have the volume already committed in our feedlots on feed now to actually see those numbers increase next year.

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Operator [6]

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(Operator Instructions) We are showing no further questions at this time. That does conclude our conference for today. Thank you for participating. You may now disconnect.