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Edited Transcript of AGRO earnings conference call or presentation 16-May-17 1:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Adecoagro SA Earnings Call

Luxembourg Aug 12, 2017 (Thomson StreetEvents) -- Edited Transcript of Adecoagro SA earnings conference call or presentation Tuesday, May 16, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Carlos A. Boero Hughes

Adecoagro S.A. - CFO

* Mariano Bosch

Adecoagro S.A. - Co-Founder, CEO and Director

* Renato Junqueira Santos Pereira

Adecoagro S.A. - Director of Sugar and Ethanol Operations

* Walter Marcelo Sanchez

Adecoagro S.A. - Co-Founder, Chief Commercial Officer and Director

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Conference Call Participants

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* Alexandre Pfrimer Falcao

HSBC, Research Division - SVP

* Isabella Simonato

BofA Merrill Lynch, Research Division - VP

* Javier Martinez de Olcoz Cerdan

Morgan Stanley, Research Division - MD

* Joao Pedro Ribeiro Soares

Bradesco S.A. Corretora de Titulos e Valores Mobiliarios, Research Division - Research Analyst

* Lucas Ferreira

JP Morgan Chase & Co, Research Division - Analyst

* Matthew Guinness

Somerset Capital Management LLP - Analyst

* Thiago Duarte

Banco BTG Pactual S.A., Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and thank you for waiting. At this time, we would like to welcome everyone to Adecoagro's First Quarter 2017 Results Conference Call. Today with us, we have Mr. Mariano Bosch, CEO; Mr. Charlie Boero Hughes, CFO; and Mr. Hernan Walker, Head of Investor Relations.

We would like to inform you that this event is being recorded. (Operator Instructions) Before proceeding, let me mention that forward-looking statements are based on beliefs and assumptions of Adecoagro's management and on information currently available to the company. They involve risks, uncertainties and assumptions because they relate to future events, and therefore, depend on circumstances that may or may not occur in the future.

Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of Adecoagro and could cause results to differ materially from those expressed in such forward-looking statements.

Now, I'll turn the conference over to Mr. Mariano Bosch, CEO. Mr. Bosch, you may begin your conference.

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Mariano Bosch, Adecoagro S.A. - Co-Founder, CEO and Director [2]

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Good morning, and thank you for joining our call. As a result of the constant improvement of our operations and the price coverage strategy of our commercial team, we continue reporting very good results.

In Sugar, Ethanol and Energy business, this is a quarter of the traditional inter-harvest season, and 2017 is the second year that we've been implementing a nonstop or continuous harvesting.

So far, we have made the same amount of grain when compared to the same period of last year. However, had more time to perform maintenance of our mills, which put us in a better position to reach the end of the season meeting full capacity.

Our expansion project is ongoing at high speed. As we explained in the previous call, our limitation is the lease and planting of new sugarcane areas. So far, we are ahead of schedule in terms of leasing new areas to supply our expansion capacity.

We believe that our track record and the reputation of the trust associated not only to our name Adecoagro but to our farming teams have made this possible.

Our daily operations continue to deliver great results despite the adverse weather conditions that have affected the business all over Argentina, proving, once again, that our production model is the most efficient and sustainable.

In rice, we have finalized the harvest with better yields than last year. The harvest of our grain production was delayed due to the excess rains, creating additional challenges in logistics. However, results remains positive and with very good yield.

As we have reported in our release, we have very attractive organic growth projects for each of these lines of businesses.

In Dairy, having proved the profitability of our production model, we have plans to duplicate our production by the contraction of 2 more free-stalls.

In rice, after the investment made in our farms, we will enhance our processing by incorporating a parboil plant and other handling equipment.

For our grain production, we have projects to increase our logistics and conditioning capacity that will translate in an enhancement of our production and add flexibility to our commercialization.

As you can see, we have a very interesting year going forward and are fully motivated to execute our strategy, consolidating as a low-cost producer for each of the commodities we produce, generating value to our shareholders.

Now I will let Charlie walk you through the numbers of the quarter.

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Carlos A. Boero Hughes, Adecoagro S.A. - CFO [3]

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Good morning, everyone. Let's jump to Page 4 of the presentation. Rains in our cluster in Mato Grosso do Sul during November 2016 through March 2017 were 25% below the 10-year average. Therefore, we decided to fine-tune our harvest schedule in order to maximize sugarcane productivity throughout the year.

As a result, we decided to slow down the pace of crushing during the first quarter, and only crush our own sugarcane that has grown between 16 to 18 months and the sugarcane purchased from third parties.

This strategy will allow our traditional 12-month sugarcane to grow an additional 2 or 3 months, and benefit from normalized rains during March and April. At the same time, any spare time was used to accelerate off-season maintenance of industrial equipment, agricultural machinery and, most importantly, sugarcane replanting.

As you may see in the bottom right chart, sugarcane replanting increased by 59% in the quarter. And we used a total of 20 days for maintenance compared to 3 days in the same period of last year. This means we are better prepared to operate at full capacity during the rest of the year.

Despite our decision to decelerate the milling pace, we were able to crush a total of 1.5 million tons during the first quarter of 2017, essentially in line year-over-year.

In terms of third-party sugarcane, we were able to find attractive opportunities to purchase sugarcane from neighboring mills and farmers at very competitive prices. Purchases of third-party sugarcane reached 221.9 thousand tons, 306.5% higher year-over-year.

Please turn to Slide 5, where I would like to comment on sugarcane productivity. Despite dry weather during summer months, sugarcane yields during the quarter reached 94.1 tons per hectare, significantly above the 5-year average yield for Brazil's center-south region, as you can see in the bottom right chart. This is explained by our focus on enhancing sugarcane quality and treatment.

Yields fell 8% compared to our yields in the first quarter of 2016 as a result of above average rainfalls during November 2015 through February 2016.

In terms of sugar content, TRS during the quarter increased to 110 kilos per ton, 3% higher than the first quarter of 2016.

Let's move to Slide 6. Sugar production decreased by 3% as a result of slightly less sugarcane yield and by the fact that production mix was slanted towards ethanol production. As a matter of fact, 62% of our total TRS production was destined to the ethanol production. This, despite being part of our commercial strategy to capture high ethanol prices during the harvest season, response to the fact that the cane crushed during the first quarter is more suitable for ethanol production.

All in all, TRS production remained virtually flat when compared to the first quarter of 2016.

In the case of energy, production increased by 54%, reaching 105,000-megawatt hour.

As for our cogeneration efficiency, it reached 72-kilowatt hour per ton, an all-time record and 59% higher year-over-year. This was primarily achieved by burning a stockpile of the gas that was carried over from last year as we expected energy prices to increase as a result of the low levels of rains registered during the last quarter of 2016.

Let's now turn to Page 7, where I would like to comment on sugar and ethanol sales. As shown on the top left chart, sugar net sales grew by 66% year-over-year. The increase is mainly explained by a 58% increase in average selling prices, coupled with a 5% growth in selling volumes.

Regarding ethanol, sales increased by 34% from the first quarter of 2016 through the first quarter of 2017. This is primarily explained by the 18% increase in average selling prices, coupled with a 13% increase in selling volumes. The increase in selling volumes was mainly driven by higher production volumes throughout the quarter.

Now let's please turn to Slide 8, where I would like to discuss energy sales. As you may see in the top right chart, energy prices have begun to rally since mid-February. Currently, spot prices are trading above BRL 350 per megawatt hour. This is mainly explained by a low rain levels recorded in the south of Brazil.

As a result, as it can be seen from the upper left chart, water levels stored in reservoirs are well below the 7-year average, thus, reducing the energy supply from hydropower. As a result, net sales grew 140%. Higher prices were coupled with an 89% increase in selling volumes.

The growth in cogeneration sales despite lower sugarcane crushing is explained by our decision to carry stockpile of bagasse from the fourth quarter into the first quarter, seeking to capture higher prices and commercialization of energy volumes from third parties. I would like to remind you that 70% of our energy exports in 2017 are hedged in long- and short-term contracts at BRL 205 per megawatt. As for 2018, 52% is already hedged at BRL 243 per megawatt.

Finally, to conclude with the Sugar, Ethanol and Energy business, I would like to focus on Slide 9. Here, we can see the overall financial performance of the Sugar, Ethanol and Energy business. Total net sales during the quarter reached $104 million, 51% or $35 million higher than the same period of 2016. As explained during the previous slide, the growth is mainly explained by the increase in selling volumes coupled with higher selling prices.

Adjusted EBITDA increased significantly during the quarter, from $22.1 million in the first quarter of 2016 to $30.3 million in the first quarter of 2017.

In addition to volumes and prices, adjusted EBITDA was positively affected by a $14 million gain from the mark-to-market of sugar hedge position.

Nonetheless, EBITDA margins fell from 37% to 33%. Lower margins are explained by a 49% increase in production costs.

I'd like to highlight that costs are highly seasonal and very difficult to compare quarter-by-quarter. Costs should be analyzed on a full year basis. The increase in costs was driven by a 378% increase in third-party cane purchases, driven by our strategy to postpone the harvest of own cane and maximize milling of cane from suppliers coupled with the higher CONSECANA prices and the appreciation of the Brazilian real in the quarter.

We expect Unit 2 production costs to decrease as the pace of the harvest accelerates and we begin crushing a higher portion of owned sugarcane.

I would like to shift your attention to Page 11, where I would like to comment on the status of our 2016 and '17 crop. The harvest of our summer crops is currently under way. The crops are in excellent conditions due to the good weather during the growth season. We expect above-average yields. However, abundant rains over the last month have generated logistics complications.

Regarding our winter wheat crop, as of March 2016, the harvest was already completed. Harvested area increased by 17% compared to the previous harvest year. Yields were at 32.8% higher than the previous harvest year, reaching 3 tons per hectare.

In the case of rice, the harvest is almost fully completed. Over 39,000 hectares were successfully harvested, yielding 5.9 tons per hectare, 16.5% higher than the previous harvest.

Let's move to Page 12, where I would like to walk you through the financial performance of our Farming business. Consolidated EBIT was $18.1 million, 28% lower than the first quarter of 2016.

In the case of our crops business, adjusted EBIT had decreased by 27% to $12.2 million. This fall is primarily explained by the delay in planting and harvest operations as a result of the excess rains during the beginning of the year. This naturally implied the postponement of the margin recognition and an increasing cost measured in dollar terms as a result of the real appreciation of the Argentinian peso throughout the year.

It is important to highlight that this decrease is primarily temporal in nature. Therefore, we expect stronger performance in the crops and rice businesses in the upcoming quarters as these seasonality issues are reversed.

Regarding the rice crop, despite a 16.5% increase in yields, margins were negatively affected by higher harvesting expenses due to setbacks caused by the rains and a 21.1% decrease in white rice sales due to schedule of shipments, but partially offset by a 14.6% increase in white rice prices.

Consequently, as we ramp up sales volumes during the upcoming quarters, we expect to offset the reduction in margins reported in the coming quarter.

In terms of foreign exchange, our costs of production in Argentina have been slightly increasing in dollar terms as a result of the appreciation of the Argentine peso in real terms.

In the case of our Dairy business, average selling prices surged as a result of a lack of supply in the domestic market. This, in turn, was caused by the floods registered during the beginning of the year, which compromised productivity and production at a country level.

Our operational performance during the quarter was very good, and we continue to see improvements as we consolidate the free-stall facility. Milk production volumes reached 21.6 million litters, marking a 0.8% increase year-over-year, driven by a 1.5% increase in productivity and a 0.4% growth in our dairy cow herd.

The gains from productivity were offset by lower selling prices resulting in a decrease in adjusted EBIT.

Let's now turn to Page 14, which shows the evolution of Adecoagro's consolidated operational and financial performance.

On a consolidated basis, net sales increased year-over-year, from $117 million in the first quarter of 2016 to $160 million in the first quarter of 2017. The 36% increase is explained primarily by higher selling volumes coupled with higher average selling prices.

Adjusted EBITDA in the first quarter of 2017 totaled $45 million, representing a 4% increase compared to the first quarter of 2016. The improvement in financial performance was primarily driven by higher sales volumes, higher prices, coupled with the mark-to-market of our commodity hedge positions. These positive effects were partially offset by an increase in production costs, mainly as a result of the currency appreciation.

We expect our required production volumes and financial performance to continue growing in line with historical growth, mainly driven by the consolidation of our sugarcane cluster and an increase in operational and financial efficiencies in each of our businesses.

Please turn to Page 15. As you may see on the top left chart, our gross and net debt as of March 31 of 2017 stands at $796 million. Our net debt stands at $565 million, slightly lower compared to March of 2016.

I'd like to highlight that 71% of our debt is in the long term, composed mainly of loans from multilevel banks at very competitive rates.

To conclude, please turn to Page 16, where I would like to share our current growth strategy. Regarding the Sugar, Ethanol and Energy business, we are currently undergoing the expansion of our cluster in Mato Grosso do Sul, as announced in the fourth quarter of 2016 earnings release.

The expansion of the Angelica mill is already complete. We have installed larger mill rollers and expanded the sugarcane centrifugation and ethanol filtration processes. Nominal crushing capacity has increased by 0.9 million, from 4.7 million tons per year to 5.6 million tons per year.

As for the Ivinhema Mill, we have begun building the foundations for the new mill tandem.

Regarding the expansion of our sugarcane plantation to supply the new milling capacity, we have already leased the necessary land scheduled to be planted in 2017 at prices according to budget. Planting activities are being executed as planned. We have successfully planted 7,000 hectares or 28% of the targeted area for 2017.

Moving to the Farming business. We have identified several accretive investment opportunities throughout our current operations. These investments will allow us to increase operational efficiency, reduce costs and enhance returns across our dairy, rice and crops segments.

In the Dairy business, we plan to invest $50 million over the next 4 years to build our third and fourth free-stall facilities. This project will allow us to double production capacity, reaching over 185 million liters of fluid milk production per year and over 14,000 milking cows.

Regarding our Rice business, during the second half of 2017, we will invest $6 million in various equipment and machines to improve our rice processing and distribution, and increase the value of main byproducts. These projects include a rice parboiling plant, a new packaging machine for branded white rice, expansion of finished goods storage capacity, a rice husk bailing press and a rice bran oil deactivation system. This will allow us to strengthen our brand in the local market and increase margins.

Finally, as for the crops business, we consider that in order to continue managing our production capacity efficiently, we will build 2 new storage and conditioning facilities located near the Rosario and Bahia Blanca ports. These assets will allow us to reduce our conditioning and logistic costs and enhance our commercial flexibility. Total investment is expected to reach $11 million over the next 12 months. These investments are expected to generate returns well in excess of our cost of capital.

Thank you very much for your time. We are now open to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Lucas Ferreira of JPMorgan.

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Lucas Ferreira, JP Morgan Chase & Co, Research Division - Analyst [2]

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My first question relates to the receipts of your free cash flow from the previous crop. And I suppose the free cash flow of the current crop will be also pretty high. So wondering what are you guys planning to do apart from the projects you already mentioned in your presentation in terms of M&A or dividends, that would be very interesting.

And if you also could comment on the land market in Argentina, if you think that the market will at some point start to see more transactions. Or if the landowners are still waiting kind of what's going to happen with the mid-term elections or the outlook in the political environment before taking any action in terms of buying and selling land? That would be my questions.

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Mariano Bosch, Adecoagro S.A. - Co-Founder, CEO and Director [3]

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Thank you, Lucas, for your questions. Regarding the cash flow generation, last year, cash flow generation, as you've seen in our financials, we've been reducing debt to the levels where we feel much more comfortable. And we say, today it's a cash flow generation, we are also presenting very attractive growth project, as Charlie was just explaining and in detail of each one of them.

So with our existing businesses, we are finding very good synergies, and we feel very attractive -- or very attracted by these projects we are sharing today. This is something in which -- or these projects are all projects in which we've been working for long. And now we feel it's the right moment to announce them and to start executing them. So that's my initial reaction to your question.

Of course, there is all the year to go, so depending on FX, yields, prices, commodity prices, et cetera, the cash flow generation could be in excess of what we are talking. And so in that case, we'll continue analyze, and we'll continue being disciplined in how we allocate capital. Of course, buyback or dividend is always a part of how we think in capital allocation.

Then on your second part of the question, the land prices, that's an interesting question. And there are really very few transactions, and when we talk about very few transaction, it's not only in Argentina. So in terms of the land market, it's been difficult to predict what the prices are because there are being very few transactions in Argentina, Uruguay and Brazil.

And so we don't have a clear answer here. I may think that after mid-term elections, there may be more movement or more liquidity in terms of transactions. That's conceptually the answer.

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Operator [4]

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Our next question comes from Isabella Simonato of Bank of America.

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Isabella Simonato, BofA Merrill Lynch, Research Division - VP [5]

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My question is regarding the new projects that you guys announced. If you could share with us what level of returns are we talking about for each of these projects, and that's it.

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Mariano Bosch, Adecoagro S.A. - Co-Founder, CEO and Director [6]

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Thank you, Isabella, for your question. In terms of Sugar, Ethanol and Energy, we've already explained in the last quarter, the level of returns and this -- and they are marginal returns to our existing operation.

In the case of sugarcane, they were well above the 20% and even as with today's prices and with today's scenario, this 30% return is still there in terms of Sugar, Ethanol and Energy. Then going to what Charlie just explained, all of them are synergetic to what we currently have.

So in terms of the grain operations and these grain handling facilities are part of our overall commercialization strategy. And this is something that is a need, not only for us, it's a need for Argentina. As Argentina has increased corn and wheat production there is a higher need to condition those crops.

That's why the profitability of this added capacity of what we are currently doing is very high. And when we're thinking very high, we're always talking about a 20% IRR in a very conservative assumptions. That's for the grains, as an example.

Then for the rice, all the projects Charlie were just mentioning, each one of them has a specific IRR, but all of them are above this 20% expected IRR.

Then when we talk about the rice -- sorry, when we talk about the dairy, the dairy is duplicating our current capacity. So within our current capacity and with the current scenario of prices and cost of production in Argentina, we've generated very attractive return this quarter.

Last year was a very bad year for the dairy system, and we proved even in a very bad year to generate $6 million. So in an average year, we would expect to generate $10 million. And we are talking about of -- total investment of $50 million. So the cash-on-cash of this would be around 20%. So that's conceptually what we are doing with the dairy business.

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Operator [7]

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Our next question comes from Alex Falcao of HSBC.

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Alexandre Pfrimer Falcao, HSBC, Research Division - SVP [8]

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Quick question on sugar. You comment on -- you're looking at lower prices for this harvest. Can you elaborate on that? And why that your competitors seem to actually going the opposite direction on their hedging policies, they're hoping for higher prices? And the other question related to this is, are you seeing any effects on El Nino at all? Are you guys preparing for that? And if so, anything for the second half of the year?

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Mariano Bosch, Adecoagro S.A. - Co-Founder, CEO and Director [9]

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Hi, Alex. In terms of our view of the sugar prices, we are not [worried] in future sugar prices. Having said this, we were covered with 58% at -- with very attractive prices because at that time, we thought that $0.193 was an average, a very attractive average price. So that's why we were -- we are hedged.

But going forward, we are not [worried] in terms of sugar prices. We think that the fundamentals are still there, and we should expect better prices going forward with sugar prices. And the El Nino effect, Marcelo Sanchez here, our Commercial Director, that can comment on -- more specific on this.

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Walter Marcelo Sanchez, Adecoagro S.A. - Co-Founder, Chief Commercial Officer and Director [10]

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Regarding the El Nino effect, it was most -- the possibility of 50% of chances of El Nino coming forward on the second half of the year that, of course, will be affecting the production in most of the country, but mainly in Brazil. And I think that that's another additional supportive item for prices for the second semester.

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Alexandre Pfrimer Falcao, HSBC, Research Division - SVP [11]

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Okay, perfect. Just final question. How you guys are seeing the fertilizer, the contracts that you guys are negotiating going forward. We saw an uptick there for this harvest. Are you guys seeing any indication, how you guys are thinking about that for the second half of the year?

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Mariano Bosch, Adecoagro S.A. - Co-Founder, CEO and Director [12]

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Sorry, Alex, can your repeat the question, again?

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Alexandre Pfrimer Falcao, HSBC, Research Division - SVP [13]

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Yes. So I just wanted to know how you guys are seeing the future of market for fertilizers as you prepare for the next harvest, or as you guys are looking for the planting for some of the [cultures] for the second half. Is there any change there, anything that should concern us in terms of input prices?

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Mariano Bosch, Adecoagro S.A. - Co-Founder, CEO and Director [14]

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Now it's clear, Alex. I would ask Marcelo to answer that question.

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Walter Marcelo Sanchez, Adecoagro S.A. - Co-Founder, Chief Commercial Officer and Director [15]

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No, Alex. We think that the current prices -- current level prices for fertilizers, so far, are also following oil prices as well. Then we don't see an increase in prices for the next coming months, although that we do have roughly 30% to 40% of our fertilizer already bought. And I think that we won't have any negative effect on the prices so far.

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Operator [16]

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Our next question comes from Thiago Duarte of BTG.

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Thiago Duarte, Banco BTG Pactual S.A., Research Division - Analyst [17]

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I have 2 questions. The first one is starting with the Farming business in Argentina. So just wanted to get a sense of what your expectations are for EBITDA generation for this year compared to the $54 million that you generated last year.

I mean, there are a couple of moving parts that I understand as being very important such as the appreciation of the Argentinean peso in real terms, and -- but are you also, on the other hand, expecting much higher yields for this year? So just wanted to, if you could, elaborate a little bit on how you see the EBITDA generation coming from there, that would be very helpful.

And the second question is regarding your sugarcane or sugar business in Brazil. First of all, whether you see -- where you see your crushing volumes going for this year. If I'm not mistaken, in the last conference call, you discussed your view of having a little bit lower crushing volumes this year as opposed to what you did last year, a little bit higher than 11 million tons.

But when you look at what you did in the first quarter in spite of the higher number of days of maintenance, you still manage to make a flattish year-over-year volume. So I was wondering whether you're still going to be able to meet last year's figures considering normal weather for the rest of the year.

And the second part of that question, where you see your production costs, unitary production cost in BRL terms for the sugar and ethanol business. Is it too conservative to believe in flattish year-over-year cost, and where you see that going? That would be very helpful as well.

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Mariano Bosch, Adecoagro S.A. - Co-Founder, CEO and Director [18]

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Hi, Thiago. Thank you for your questions. Regarding farming and land transformation in Argentina and what's the EBITDA number that we can expect, of course, we don't give guidance, but we can share with you that there are a lot of moving parts as always happen with this. We do have a much higher expectation, as you can see in the first quarter with the dairy business, so that's something that is going upwards for sure.

In rice, we are also optimistic because we are starting with a better yield than the last year, although slightly lower prices on Argentinian -- more appreciated currency that are the negative part in that part of the business. And in terms of the crops, we have -- we're having some way better yields, but lower commodity prices. And again, higher FX, higher currency for the peso. So taking into account all these moving parts, I think you are more or less in line on how we're thinking, but still a long way to go.

Then regarding the sugar and ethanol volumes, I think we've been very clear that in terms of sugar and ethanol volumes, we shouldn't expect lower than last year. We are very well prepared to crush at full capacity. And of course, these will always depend on the climate, so if we cannot mill because it's raining every day, we can't -- we won't be able to reach the full capacity. But assuming normal weather from now on, it's very clear that we should be full capacity with no doubt. That's for the sugar and ethanol volumes.

So, and the last part of your question regarding the unitary cost in Brazilian real, we will be in line with last year assuming these same volumes up as we've been talking. And there are some small efficiencies in every part of the chain that we are always increasing that maybe even improve a little bit in terms of the Brazilian real terms.

And then I can give the word here to Renato Junqueira to -- who is responsible for our sugar and ethanol business, to give a little bit more color in terms of cost analysis for the sugar -- for our sugar and ethanol costs.

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Renato Junqueira Santos Pereira, Adecoagro S.A. - Director of Sugar and Ethanol Operations [19]

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Hi. Considering the current exchange rate and productivity estimates, our cost -- cash cost in 2017 should be a positive BRL 0.30 per pound. Of course, it depends on many variables that is still [open], but that's our best estimates now.

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Operator [20]

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Our next question comes from Joao Soares of Bradesco.

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Joao Pedro Ribeiro Soares, Bradesco S.A. Corretora de Titulos e Valores Mobiliarios, Research Division - Research Analyst [21]

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Basically, if you guys can give us some color on your -- you mentioned that ethanol is a little bit more profitable. We see that especially in the Midwest, given current sugar prices, that ethanol production has already become more profitable, not only in terms of margins but also in terms of working capital.

So if you guys could give us some guidance on how you're expecting your mix, if you consider that sugar prices -- I understand you're optimistic that prices of sugar will go up again. But imagine the scenario sources sustains, how are you imagining your mix for the end of the year? That will be my question.

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Mariano Bosch, Adecoagro S.A. - Co-Founder, CEO and Director [22]

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Okay, thank you, Joao. I will ask Marcelo Sanchez to answer this question. Marcelo?

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Walter Marcelo Sanchez, Adecoagro S.A. - Co-Founder, Chief Commercial Officer and Director [23]

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Thank you for the question. Regarding our strategy for the ethanol taking advantage in our situation in Mato Grosso do Sul. Today, we do have 9% premium on the sugar price with the anhydrous production. Therefore, our strategy will be producing as much anhydrous as possible within this coming months in order to be able to capture that premium.

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Operator [24]

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Our next question comes from Javier Martinez of Morgan Stanley.

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Javier Martinez de Olcoz Cerdan, Morgan Stanley, Research Division - MD [25]

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If I may ask, again, about sugar prices on your commercial strategy, please. Because my reading of what you have released is a little bit different from the comments I have been listening before. I don't -- I didn't read that you are optimistic or pessimistic, I think that -- what you are saying is that you expect price volatility going forward.

And given that you have already hedged at great prices more than half of the production, probably you're already covering most of the fixed cost for this year. What I want to understand is, Marcelo, what is your level of flexibility?

So do you have flexibility considering your hedging policies to wait for prices to recover or not? At [a certain] point you have to keep closing prices to cover cost, or how does it work? So how flexible -- how -- what is your commercial strategy on sugar prices going forward?

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Walter Marcelo Sanchez, Adecoagro S.A. - Co-Founder, Chief Commercial Officer and Director [26]

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Thank you, Javier. Yes, we do have flexibility going forward. As you mentioned, we are hedged 58% at $0.193. The flexibility that we do have will be from our -- from the view that we don't have in the sugar, we'll be able to capture this upside in the prices for the rest of the year.

If Brazil is coming up with a lower harvest, that would, I think, what we think that -- at the level of 580 million tons of crushing, that will be the range of Brazil at the end of this year. Prices will be coming up from these levels. And we think that we would be able to capture that, given that we are open.

And for 2018 prices that we are already hedged 20%, 22%, we do have some optionality. The hedges that we don't have considers options as well, that will be also able to capture in case of an upside for next year.

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Javier Martinez de Olcoz Cerdan, Morgan Stanley, Research Division - MD [27]

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So you don't have any limitation to wait -- to close anymore prices for sugar for another, let's say, quarter or 2 quarters, or [fiscal year]?

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Mariano Bosch, Adecoagro S.A. - Co-Founder, CEO and Director [28]

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Yes, for the next 2 quarters for sugar, that, we don't have any limitation.

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Javier Martinez de Olcoz Cerdan, Morgan Stanley, Research Division - MD [29]

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Great. If I may ask something as -- out of curiosity, these 4 storage and conditioning projects you have, this is for -- only for your grains or this is all potentially also a business for third-party grains?

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Mariano Bosch, Adecoagro S.A. - Co-Founder, CEO and Director [30]

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This is mainly for our grains, but can also be used for third-party's grain. Today, we already do that in the -- our existing milling capacities with 15% of third-party's grain. So it can easily be used for 15% to 20% of third-party's grain.

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Operator [31]

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(Operator Instructions) Our next question comes from Matthew Guinness of Somerset Capital.

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Matthew Guinness, Somerset Capital Management LLP - Analyst [32]

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I was wondering if you could provide a little bit more color on how the dairy business -- what operational similarities there are with the dairy business compared to your existing businesses and, therefore, why you have a competitive advantage in that business.

And then linked to that, I'd be interested to hear your thoughts on dividends and/or buybacks. Is that sort of a last resort for free cash flow or might you pay one? And then secondly, could you just go into a little bit more detail about the margin contraction in the Farming business and the causes of that?

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Mariano Bosch, Adecoagro S.A. - Co-Founder, CEO and Director [33]

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Thank you, Matthew, for your question. Regarding the dairy, the specifics of what we have today is absolutely unique in South America. There is nobody else with the production system that we have there in South America. If you haven't been able to take a look at it, I think it's -- the things that we are proud of what we've done. And this is the most efficient system to produce milk in South America.

And when we compare to the best producers of North America that are with which we compare, we are always within the 10% superior guys. So that's what we've developed in Argentina and it took us almost 10 years to develop this system. And now we feel that system is in an optimal situation and ready to be expanded. That's the main benefit that we have in our dairy business, and that's why we are interested on growing with that business. And we think that's a very attractive use of capital.

Then regarding the cash flow generation, as I mentioned before, there are still a lot of things to happen during the year, so depending on how much cash we'll be generating, we will always analyze these different options when we are thinking on capital allocation in which we include the buyback or dividends as part of the analysis. As you've seen, for example, in the last 6 months, we've been buying back some shares as reported in our 20-F in April.

And finally, regarding the contractions in margins, that contraction -- when we are reporting this particular quarter, that contraction is higher because we haven't harvested yet all those grains. So part of that contraction is delaying of the harvesting that has happened because of the rain that generated a delay on the planting. And then, obviously, postponed on the harvesting.

So in some ways, they were postponed. But having said this, in terms of the grains, in general, as we have a more appreciated peso, there is also some kind of structured construction in terms of those margins coming from the land.

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Operator [34]

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This concludes the question-and-answer section. At this time, I would like to turn the floor back to Mr. Bosch for any closing remarks.

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Mariano Bosch, Adecoagro S.A. - Co-Founder, CEO and Director [35]

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Okay, thank you very much for participating on the call. And we expect a very good year going forward, and we -- and all our teams are fully motivated to continue developing this company. We are proud of what we've done until now. And we are fully motivated to continue growing and generating attractive returns for our shareholders with this company. We expect to see you in our upcoming events.

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Operator [36]

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Thank you. This concludes today's presentation. You may disconnect your line at this time, and have a nice day.