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Edited Transcript of OFSA3.SA earnings conference call or presentation 6-Nov-19 6:00pm GMT

Q3 2019 Ouro Fino Saude Animal Participacoes SA Earnings Call

Nov 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Ouro Fino Saude Animal Participacoes SA earnings conference call or presentation Wednesday, November 6, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jardel Massari

Ouro Fino Saúde Animal Participações S.A. - CEO, Member of Executive Board & Director

* Kleber Cesar Silveira Gomes

Ouro Fino Saúde Animal Participações S.A. - CFO, Member of Executive Board & Chief IR Officer

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Conference Call Participants

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* Antonio Costa Barreto

Itaú Corretora de Valores S.A., Research Division - Research Analyst

* Eugenia Tedde Cavalheiro

JP Morgan Chase & Co, Research Division - Research Analyst

* Luciana de Carvalho

BB-Banco de Investimento S.A., Research Division - Senior Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Ouro Fino Saúde Animal Third Quarter 2019 Conference Call. Today, we have with us Mr. Jardel Massari, CEO; and Mr. Kleber Gomes, Chief Finance and Investor Relations Officer. We would like to inform you that this event is being recorded and simultaneously translated. (Operator Instructions)

The audio is being presented through our site ir.ourofino.com, where you will find the Webcast Third Quarter '19 banner.

Before proceeding, we would like to mention that forward-looking statements made during this conference call referring to the outlook, operational and financial goals represent the assumptions and beliefs of the company and are based on information currently available for the company. There are no guarantee of performance as they involve risks, uncertainties and assumptions and 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 Ouro Fino and cause results to differ materially from those expressed in such statements.

I would now like to give the floor to Mr. Massari, you may proceed.

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Jardel Massari, Ouro Fino Saúde Animal Participações S.A. - CEO, Member of Executive Board & Director [2]

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A good afternoon to all of you, and thank you for participating in our earnings conference call for the third quarter '19. The Brazilian animal health market, more specifically the Production Animals segment has its potential reaffirmed in light of the context of historically higher beef prices and lower grain prices, along with a positive impact for the Brazilian agricultural sector due to the challenging scenario of the African swine fever which continues to devastate pig herds in China. According to the USDA, the U.S. Department of Agriculture, Chinese production is estimated to be 36% lower in 2020 vis-à-vis the year 2018, providing opportunities for Brazil to significantly increase protein production and exports, which is something that has already been happening at considerable speed in terms of volume. We understand that this scenario will operate as a catalyst for the growth of the animal health market, considering that to meet this additional demand, farmers tend to intensify the search for technology that may increase the productivity of their livestock.

Notwithstanding this during the third quarter of 2019, the animal health market did not achieve this potential, which we believe is due to a possible insecurity of farmers regarding the macroeconomic scenario, which has also impacted the results we expected from the typical trade fairs in the sector. Accordingly, the Production Animals segment presented net revenues of BRL 120 million, a decrease of around 6% when compared to the third quarter 2018. Results were also impacted by the concentration of sales at the end of September, exceeding BRL 9 million when compared to the same period of the previous year, and revenue recognition was done at the beginning of October.

In the company's consolidated accounts for the quarter, sales revenues decreased by 4%. The Companion Animals segment increased 11%, thanks to -- but there was a decrease of 6% in the Production Animals segment, and International Operations segment had a decrease of 5%. Results of the International Operations segment would have remained stable were it not for the exchange rate.

Adjusted EBITDA reached BRL 28 million, a decrease of 8 percentage points in the margin, which also was the result of the 5 percentage point impact on gross margin due to the increased idle costs at the plant.

On the positive side, the generation of cash from operations remains strong, totaling BRL 81 million for the 9 months of 2019, that is, to say, 53% higher than the same period of 2018 as well as the good revenue growth for both Companion Animals and International Operations segment.

Regarding the future and always in the quest for continuous improvement for our company, we have completed the diagnosis phase and the definition of our strategy in the context of a new strategic planning cycle for Ouro Fino for the coming 5 years in partnership with EY-Parthenon consulting firm. At this point, we reaffirm our position for reimagining animal health as a comprehensive portfolio company with accelerated international expansion in Latin America and a close business relationship with our partners to deliver productivity to farmers and the reassurance of good care for Companion Animals to pet owner.

We have defined the strategy for expanding our portfolio in the Production Animals segment as well as for increasing our presence in the Companion Animals segment by increasing the coverage of the animal health market with the entry into and strengthening of the brand in certain subsegments. In this context, the project for consolidation of the platform of biological products is under development with investments in research and development, following the open innovation model. As regards International Operations, we will consolidate our presence in Mexico and Colombia, including a broader portfolio in those countries which, when combined, represents about half of the Brazilian market.

Our team is committed in implementing our strategic planning process across all of its transformation pillars and defined initiatives, so that in a sustainable way, we can deliver value to our stockholders, customers, employees and suppliers.

I would now like to give the floor to Kleber Gomes, who will speak about the financial results for the quarter.

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Kleber Cesar Silveira Gomes, Ouro Fino Saúde Animal Participações S.A. - CFO, Member of Executive Board & Chief IR Officer [3]

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Thank you, Jardel. We will now go on to the financial results. The company had net revenues of BRL 154 million in the third quarter '19, a reduction of 4% vis-à-vis 2018. For the 9 months, there was a growth of 2%, reaching BRL 423 million.

In Production Animals, the net revenue was BRL 120 million, a reduction of 6% vis-à-vis 2018.

In the 9 months, net revenues reached BRL 318 million with a decrease of 1%. There was a loss of volume offset by price gains. Additionally, the concentration of sales at the end of September with an additional BRL 9 million has an impact on the quarter results. Now otherwise, the net revenues would have been BRL 129 million in the quarter.

The Companion Animals segment had net revenues of BRL 20 million with a growth of 11% vis-à-vis the third quarter 2018. This was due to an increase in volume along with an increase in prices. For the consolidated results of 9 months, net revenue stood at BRL 63 million with a growth of 12% vis-à-vis the same 9 months the previous year.

For International Operations, net revenue reached BRL 15 million with a reduction of 5% due to exchange losses. In the 9 months of 2019, net revenues were BRL 42 million with a growth of 16%, with a gain in volume and price and a favorable exchange rate. If we don't consider the exchange impact, Mexico had a growth of 12%, Colombia an expressive 26%, while the revenue of other countries remain stable vis-à-vis the same period 2018.

I would now like to speak about the gross margin for the third quarter 2019. The consolidated margin was 52% with an increase (sic) [decrease] of 5 percentage points vis-à-vis the same period 2018. For the 9 months, gross margin was 50% with a reduction of 5 percentage points vis-à-vis 2018. Generally, this reduction of margin is due to a greater idleness at the plant.

Last year, we had a revision and an increase in the level of finished products, representing a total of BRL 24 million, enabling us to enhance our gross margin.

Production Animals had a gross margin of 49%, a decrease of 6 percentage points when compared with the third quarter of 2018. For the 9 months, gross margin was 46%, with a 6% drop. Once again, the lower use of our production capacity was the cause of this. Additionally, there was a new state decree that made it impossible to accumulate the ICMS taxes.

Companion Animals had a gross margin of 69% in the third quarter, a gain of 2 percentage points vis-à-vis 2018, reflecting the price gain for the period. In the 9 months of 2019, gross margin was 70%, a decrease of 1 percentage point. And once again, this was partially offset with price gains.

International Operations had a gross margin of 57% in the third quarter with a drop of 6 percentage points, and it also reflects the lower use of our production capacity and exchange losses in Mexico. We also had a significant sale of the Foot and Mouth Disease to other countries, impacting the margin in the segment. We had a drop of 7 percentage points for the 9 months, once again, to the lower volumes produced at the plant with a partial offset by price gains.

We will continue with comments on SG&A, investments in research and development and adjusted EBITDA.

Sales expenses added up to BRL 59 million, equivalent to 38% of our net revenue, an increase of 3 percentage points vis-à-vis 2018. For the 9 months, we obtained BRL 169 million equivalent of 40% of the net revenue, an increase of 3 percentage points vis-à-vis the same period in 2018. These results reflect our expenses with research and development BRL 9 million higher vis-à-vis the 9 months of 2018, and an increase of 4% in expenses not diluted due to an increase that we expected in revenues. And we also had a provision of profit and results that had been provisioned throughout 2019.

Now once again, we continue investing 70% of our net revenues in research and developing, totaling BRL 31 million.

Adjusted EBITDA for the quarter was of BRL 28 million with an 18% margin, a decrease of 6 percentage points vis-à-vis 2018. For the 9 months adjusted EBITDA totaled BRL 63 million, a decrease of 8 percentage points. These results reflect the losses of gross margin, as mentioned, besides these factors referring to an increase in sales, general and administrative expenses.

I would now like to speak about our net financial expenses for 2019 that amounted to BRL 3 million, a variation of 10% vis-à-vis the same period the previous year. For the 9 months, it stood at BRL 10 million.

Regarding the average cost of debt, there was a reduction of 7% a year, reaching 6.6% per annum for the third quarter 2019.

Income tax and social contribution was of BRL 5 million and BRL 12 million for the 9 months with a tax rate of 35%. I would like to remind you that the Ouro Fino pet company was taxed based on the deemed profit until 2018. But then we also had the impact of losses in International Operations subsidiaries that are not deducted from the profit before income.

Regarding adjusted net revenue for the third quarter, it was BRL 13 million with a net margin of 9% and a decrease of 7 percentage points. For the 9 months, a total of BRL 22 million with a reduction of 7 percentage points.

I would now like to speak about the indebtedness and cash generation of the company. The net debt over EBITDA ratio for the last month was up 2x. This increase is due to the decrease of EBITDA, and we had BRL 220 million in September 30, 2019, compared to BRL 229 million for 2018. 60% of our debt is a long-term debt.

For the 9 months, there was amortization of debt and the payment of interest, totaling BRL 78 million, CapEx, BRL 34 million and tax payments of the BRL 11 million, offset by a robust operating cash generation of BRL 81 million, 53% higher than the 9 months of 2018.

I would now like to turn the floor over to the operator for questions and answers.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Mr. Barreto from Itaú BBA would like to pose a question.

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Antonio Costa Barreto, Itaú Corretora de Valores S.A., Research Division - Research Analyst [2]

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I would like to understand what happened with the performance of Companion Animals that is somewhat below expected, which are the product lines that are weaker? In your initial address, you stated that you had optimism due to the African swine fever, but that this did not contaminate the market but we saw greater weakness compared to the first quarter. If you could elaborate on this and the performance of Production Animals?

And as a second question, still referring to the same topic. As we think about your direct customers, you have the store of farmers and farmers themselves. If you could remind us, which is the mix with these 2 audiences? And what happens when you have a drop in access to credit for these 2 different customers separately if the impacts are different?

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Jardel Massari, Ouro Fino Saúde Animal Participações S.A. - CEO, Member of Executive Board & Director [3]

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Thank you for your question. The first question refers to the reduction in the consumption of veterinary products. Well, this year, specifically, most of the companies have a sales volume that is below what was desired or expected. And at Ouro Fino, there is a specificity our product line for ruminant, for example, works with concentrated products and others, and this is our own perception. Now we did not have a significant drop in the regions where we have prior year incidence of disease. I'm referring to chicks. This is one of the most profitable products that we have. And I think that this drop was caused to the mix anti-inflammatory therapies, for example, that gave us a much lower margin. And we did not have a great incident this year because of the lack of rainfall. The rainfall is just beginning, and of course, this should lead to an improvement for the end of the year and the year 2020.

In terms of your second question, the different audiences, the agricultural stores and farmers. There are no great differences. And what happens is due to the macroeconomic expectation of farmers and producers, there still haven't been significant changes in the government policy. This decree in interest rate will take some time to have an impact and stores were quite stocked up. They are decreasing their stocks, they're holding back capital. And I think that eventually, all this will return to normalcy in the coming days. Kleber?

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Kleber Cesar Silveira Gomes, Ouro Fino Saúde Animal Participações S.A. - CFO, Member of Executive Board & Chief IR Officer [4]

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This is Kleber Gomes. I'm going to complement your question on our mix of customers. Our direct sales to farmers practically do not exist. We know that the volume is quite small, except for the very large farmers that we work with. And this is due to the logistics that we have and the policy that we have of privileging the channel in Production Animals when it comes to concentrated fleets, we sell these in stores and in large cooperative. And if we look at pigs and herd, we have the B2B which is how we sell our products to farmers. At present, we have great market access, the greatest, perhaps. And every month, we invoiced to 4,500 new when it comes to Production Animals.

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Operator [5]

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Mrs. Luciana Carvalho from Banco do Brasil would like to pose a question.

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Luciana de Carvalho, BB-Banco de Investimento S.A., Research Division - Senior Analyst [6]

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Still referring to Production Animals. You mentioned that at the end of September, you had BRL 9 million in sales. Now how much of this represents volume? How much of this is due to price? If you could break down this figure and tell us what will happen with October if this trend continues?

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Jardel Massari, Ouro Fino Saúde Animal Participações S.A. - CEO, Member of Executive Board & Director [7]

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Luciana, simply to clarify this, I -- to make sure I understood the question correctly. What we mentioned was that the invoice sales that had not been recognized were higher by BRL 9 million during the period and all of this was delivered. And in October, we believe that our invoicing will be somewhat lower.

When it comes to prices, we have been suffering for some years with an increase in costs, and this happened last year because of the situation in China. And we are attempting to go and work with prices that are somewhat above inflation. This has been possible, and the main variations are probably due to volume.

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Luciana de Carvalho, BB-Banco de Investimento S.A., Research Division - Senior Analyst [8]

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And when it comes to the competitive environment, if you could remark on what you believe will happen going forward in the third quarter, there have been some changes. You have made changes in your portfolio to gain more strength. And you have an Austrian Group that is acquiring a laboratory in Minas Gerais, which are your movements? And what is your outlook going forward?

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Jardel Massari, Ouro Fino Saúde Animal Participações S.A. - CEO, Member of Executive Board & Director [9]

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Now this question, of course, is always very pertinent. We know that the competitive environment in animal health in Latin America is extremely strong as Latin America is the great supplier of protein worldwide, and this grows and grows when we look forward, and when we think about the proportional increases that we should have and the meat consumption in emerging countries, all of the large companies have settled in Brazil. We know that all of these companies together represents a large majority in the market. And because of this, Ouro Fino is the only local company that has been able to position itself and to compete on an equal footing with these large companies in the sector. We offer a full portfolio. We have a differentiated system to producers. We have a broader geographic coverage, extremely good processes and much more.

In this context, this competitiveness is extremely harsh, but we have been able to maintain a very strong position. As you mentioned, we do observe a segment where it's a great deal of business combination. You mentioned a merger of Elanco and Bayer was representing $7 billion placing Elanco as the second most important company worldwide. We're following up on this and what we have is a strategic plan. This was mentioned at the beginning, and we understand that we do not have sufficient size to carry out a similar transaction. But of course, we can increase our innovation model, our open innovation model. We can seek additional partnerships. We can acquire companies and products. And this is an area that we are reinforcing through this new project so that we can continue on because of the positive points that we have in Latin America and ensure that we continue our enhancement process and make the most of the market opportunities.

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Operator [10]

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Mr. Eugenia Cavalheiro from JPMorgan would like to pose a question.

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Eugenia Tedde Cavalheiro, JP Morgan Chase & Co, Research Division - Research Analyst [11]

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In truth, I have two. The first refers to the biological products. They should be coming into the market in a year or 2. And secondly, the margin for Production Animals. We observed an expressive drop in that margin, and what is it that we can expect going forward or will this margin continue to be contracting?

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Jardel Massari, Ouro Fino Saúde Animal Participações S.A. - CEO, Member of Executive Board & Director [12]

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Eugenia, thank you very much for your question. I would like to begin by the last question. Throughout the year and last year at Ouro Fino, our vision was that we would begin this year under greater pressure when it comes to the plant result. We know that we are running a new biological plant with a single product, which, of course, does have an impact. So we have always been very transparent. As always, we had greater expectations for this year that did not materialize. And of course, this represented a lower volume of production and higher inventories. This led to a lower dilution of costs. Our secret here is quite obvious to seek growth, to seek sustainable growth, growth that will be constant and above the market. But unfortunately, this year, this did not materialize up to the moment, and we are still attempting to better understand the market data that we have at hand. We have data only for the first semester, showing that the Production Animals segment is not advancing as expected. And perhaps, the producers are awaiting to see what will happen in Brazil. All the conditions are positive. We see that other companies are doing business. The market is positive, and the condition of the producers is positive. Unfortunately, the market continues to await to show a certain retraction. And all of this caused pressure on the plant due to the lower volumes and lower revenues.

When it comes to the biological products, we do have a plan. It's a very complex plan. The plant is ready. The first project has been launched. We have other products under development as part of our pipeline for the year 2020. We don't expect to have too many products. These products are being prepared in a 4- to 5-year time frame as foreseen.

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Operator [13]

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Antonio Barreto from Itaú BBA would like to pose a question.

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Antonio Costa Barreto, Itaú Corretora de Valores S.A., Research Division - Research Analyst [14]

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I would like to ask a more direct question in terms of that more optimistic environment in terms of swine fever. I think that the prices I've heard have reached historical level. Can you still take advantage of this in the period of consignment? I think that the prices should increase quite a bit. Would you have sufficient time for this? And if you still have positive outlook for the animal health market this year or have -- or do producers already have a ready stock to increase their productivity, if you could please comment on this?

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Jardel Massari, Ouro Fino Saúde Animal Participações S.A. - CEO, Member of Executive Board & Director [15]

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Well, now this issue of the African swine fever is being followed up by everybody. What I would like to highlight here is the following. We do understand that we have a very good market. And we have always attempted not to become attached to any market condition. Even though we have been discussing this lately, we would like to remind you that the cost of veterinary medication is 1% to 3%. Now we are in a market that has no technology that will have to produce more proteins for the world. And what we understand in terms of the African swine fever that it is the cherry of the cake in the sense that we will be able to sell more pig herds to China. Well, the Chinese will continue to eat more protein. The other countries have supply this demand, as you know. And Brazil is beginning to serve this wave just now with the possibility of having a release further sale of other meats to China. I don't think it will have an impact this year. We have very little time for this, but it could be the cherry of the cake for the coming 2 or 3 years. If we think about the protein market and the excellent level of cooperation that exists between the raw protein market and the animal health market.

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Antonio Costa Barreto, Itaú Corretora de Valores S.A., Research Division - Research Analyst [16]

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Allow me to ask the question in a different way. Now which is the relation between the animal health market and consignment. If consignment has a growth to 10%, 15%, will this have a positive influence in the animal health market?

And another question regarding consignment. If there still is demand for consignment this year, I understand that you believe you will not be participating with this increase that this could be passed on to the coming year. So if your sales are related to consignment? This is my question, basically.

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Jardel Massari, Ouro Fino Saúde Animal Participações S.A. - CEO, Member of Executive Board & Director [17]

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I would like to complement your question on consignment. Consignment is an activity and there are very few products that are used during that period. We do have some anti-tick medication and others, but the impact will not be very great now. This is a trend that is merely beginning now, and this is a reflex that is beginning to appear in bovine cattle and pig herds. There was a record in the month of October, there is a trend, but there are other factors as we do not sell directly, so we depend a great deal on distributors now. As we believe that this will begin happening in 2020, we are going to make the most of the sale of these veterinary products.

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Operator [18]

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(Operator Instructions) At this point, we would like to conclude our question-and-answer session. We return the floor to Mr. Massari for his closing remarks.

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Jardel Massari, Ouro Fino Saúde Animal Participações S.A. - CEO, Member of Executive Board & Director [19]

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I would like to take this opportunity to invite all of you for Ouro Fino Day. This is the great market meeting that will be held on December 8, Friday in Vila Olímpia at 11:00. And this venue, we will present our strategic planning that has been done in partnership with the consulting company. We will continue to deliver value to our stockholders. And once again, should you have any questions, our IR team is at your entire disposal. Thank you very much, and have a good afternoon.

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Operator [20]

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The third quarter 2019 conference call for Ouro Fino. And here, we would like to thank all of you for your participation. Have a good afternoon.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]