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Executives

Alf-Helge Aarskog - CEO

Analysts

Gianmarco Bonacina - Equita

Marine Harvest ASA (OTCQB:MNHVF) Q2 2014 Earnings Conference Call August 27, 2014 10:00 AM ET

Operator

Good day and welcome to the MHG Q2 2014 International Conference Call. Today’s conference is being recorded. At this time I would like to turn the conference over Alf-Helge Aarskog, CEO. Please go ahead sir.

Alf-Helge Aarskog

Thank you and welcome to the presentation of the second quarter of 2014 for Marine Harvest and results. I think we then turn to page three with the highlights this quarter. What we see in general was very good result for Marine Harvest, in fact a record high profit in the quarter and also a record high volume. We had quarter-on-quarter growth from the second quarter 2013, a 44% increase in harvest volume. In terms of divestment, we've sold off and completed the divestment of Meridian. Meridian was Morpol’s farming unit or part of Morpol farming unit resolved in Scotland and Shetland. This was sold out for little bit more than NOK1.1 billion.

We initiated building of a feed factory in 2013. That was completed in June and we started production late June. We will report on the feed production results from the feed production at the end of Q3. The Board decided to payout the quarterly dividend based on the result of this quarter at NOK 1 per share.

We then turn to Page 4 and look at the key financials. We see quite good top line growth, up almost NOK2 billion from NOK 4.4 billion in Q2 2013 to NOK6.5 billion in 2014 second quarter. Cash flow was good in this quarter, up to NOK1.3 billion and the net interest-bearing debt there ended at NOK7 billion, south of our target at NOK7.5 billion for the Company.

I’ll then turn to Page 5 where you can see the development in prices or salmon prices. In Norway, the blue line, the reference price in Chile, the red line and the reference price in North America which is the green line. What you’ll see here on the back of 16%, the supply growth, expected reduction in the European market but we will see fairly stable prices and surprisingly stable prices in the U.S. market and on Chile on fish into U.S. This is surprising and really shows the strong market in this quarter, knowing that I’ve said 16% supply growth came on to the market compared to Q2 2013.

If you then go to Page 6 and look at the price achievement and here we look upon what price we achieve, measured against different reference prices in the marketplace and it takes into account the quality of fish and the contract share. We see on Norwegian salmon, close to 100% or achieving the reference price with the entire volume. The contracts started to be close to giving us margin in this quarter. They were not quite up to spot price but close in and the superior share in Norway in this quarter was quite good. So we don’t have to subtract so much in regards to the spot price, which does not take into account quality.

The Scottish achieved price was very good in this quarter. We have good contract and good contract coverage but there is also element of quite a lot of fish being harvested in this market, putting a pressure on the Scottish spot price and if you see the small print on the presentation, it’s now NOK1.48 above the Norwegian standard price. Usually this number is higher but Scottish spot price has been under pressure because of high volumes in Scotland. In terms of, and then also our contracts, we’ll see even better in this context.

The Canadian and the Chilean fish, as you can see, we don’t have any contracts in Chile, some issues in quality and achieved below the reference price, both in Canada and in Chile. The reason for not being able to compare in Chile is that we did not harvest fish in Chile in the second quarter of 2013. We then go into the Norwegian operation, which is the main operation in Marine Harvest. If you look at the volume harvested, 114,000 ton, 68,600 ton came from the Norwegian operation.

A good increase in volume and the price achievement has been or close to what the market is, slightly increased cost compared to Q2 2013, but reduction in cost from Q1 2014. What’s special with the Norwegian operation this summer over Q2 has been high water temperatures, has been very warm on the Norwegian West Coast and we’ve seen high seawater temperatures, which is not optimal for salmon. The optimal salmon temperature for growing salmon in the ocean is between 12 and 14 degrees and this summer we've seen as far as up to 18 - 19 degrees in the ocean.

One other area of concern in Norwegian operation is the sea lice issue and the fact is that we’re spending more and more money and time on solving this issue, staying below the Norwegian regulation. If you look at exceptional items at NOK 1.53 in the table compared to 0.63 in 2013, a lot of this has to do with exceptional cost in regards to sea lice.

If we then go into the contract portfolio, as you can see and that we touched base upon, it was 35% in Q2. It will increase in Q3 to close to 47% of the fish contracted and is also good levels in Q4 and Q1 2015 and this is obviously a rolling forecast and we enter into contract, not as we speak but continuously in this period.

We then go to Page 9 and look at the different regions in Norway and their performance. Region south has historically been -- at least over the last few years been the region with the lowest margin. The margin at 11.66 this quarter is decent. It's down from the second quarter in 2013 but comparably speaking we are fairly satisfied with the performance in region south in this quarter. Going forward in region south we expect higher cost in the second half of the year, due to the warm summer as I spoke about before, but also due to some PD cases and some sea lice issues, where we have to harvest to out fish slowly.

Region west performing very well at a good cost level and very good quality on the fish in that region. Region mid and we expect this to continue going forward; region mid and region north, both regions where we expect better results in the coming quarter, comparably speaking to what we see here and a slight cost reduction is expected in both these regions. All-in-all, we achieved the NOK12 per kilo, NOK12.60 per kilo in the Norwegian operation.

We then go to Page 10 and take a look into the Scottish operation, operational EBIT here at NOK223 million in the quarter on very good harvest volumes, 18,200 ton harvested. So a significant growth in volume, 37% to be a precise. This business has a lot of contracts with major clients and also have good contracts going forward and has been a stable performer over the last years. Biology is good in the region where we operate and we expect good results also going forward.

In Canada, we reduced harvest this quarter compared to the second quarter in 2013, down from 8,900 ton to 6,400 ton. This has to do with the restructuring we did in Canada in 2012, going away from sites with [indiscernible] and will have the lower production and expected production in Canada this year is 29,000 ton. In normal utilization of our Canadian operation, we will be at 40,000 ton. So there is obviously a volume effect in terms of cost in this region.

Then on to Chile, a positive result in Chile at NOK5.5 per kilo. Harvest volume 16,400 ton and there is nothing to compare to because we didn’t harvest fish in the second quarter as previously said. Cost still high in this region, 4.7 in head gutted in box calculated back to that. But we see a temporarily improvement. There has been changes into regulations in Chile and there is better coordination in the Chilean operation between the Chilean producers these days and also it’s been helped by sea lice drug called Salmosan that it has been approved for the Chilean operations. That has relieved some of the pressure on the biology. We still think that to get Chile up to the NOK11.12 area where the other farming areas are in terms of NOK per kilo produced, we need improved costs to really get the structural solutions in Chile consolidations will be required.

Ireland, Faroe Islands, will not spend too much time on that. The Irish operation is organic operation for most of the fish sold us organic salmon and farming the special rate, achieved very high price but they also have much higher costs than the other regions. Faroe Islands has little bit weak quarter compared to what we usually expect from the Faroe Islands but this is a very small operation and it has to do with what sites they are harvesting from.

Then Page 14 and we’re into the value added products in our division that’s called VAP Europe. Struggling in a tough quarter, we finalized the restructuring in June and closed down our last smokehouse, not last but our last plant in the restructuring plan and we have closed down five out of 13 plants and are left with eight, amongst them one smokehouse. Most of the market for this division is in France and that in the France market we’ve seen challenging conditions. This has to do with both financial situation in France and consumers going towards cheaper protein but it has also to do with some campaigns against salmon in France, actually backed from Norwegian NGOs.

And we’ve decided to reorganize VAP and Morpol into Marine Harvest consumer products with three divisions, fresh, chilled and frozen; fresh being MAP packed and fresh salmon, chilled being the smoked business, and frozen being frozen portions and frozen products for that market.

The chill division here, which is the smoked business will be led and headed up by the Morpol management or the Morpol team in smoked and that is to really take out the strength of the Morpol organization and also not to be in marketplace with two smoked operations and very important. The same is for the frozen business. That will be -- products will produced in Poland and headed up by the by the former end or the Morpol management team.

We think this in combination will make a very strong unit in Europe and with the restructured VAP division and a combination of them Morpol factories we have a really good divisions to head into the future within Europe. In Morpol positive results in this quarter, just slightly above market price. The spot price for the quarter was NOK14 per kilo and they still made money. I think the breakeven cost there around NOK 42 per kilo. We see that Morpol has very positive -- are in a positive situation with today salmon prices and we expect them to have a much better second half than the first half this year.

Then on to Page 16, the feed operation, as already said, we decided to go into fish feed in early 2013. We have completed our first factory. The capacity here is 220,000 ton currently. We started production late June and in July we manage to get up to two third capacity utilization and we will start reporting this in the third quarter and we expect this division to breakeven in Q3 in 2014.

We have obviously had start up issues with all-in-all being able to build this factory, start it up on time, actually little bit ahead of time and commence production and reproduced 16,000 ton of feed in July is a success story. It’s a very modern factory, LNG run and very efficient in terms of the way it produces feed.

We then go on to Page 18 and I will go through the main numbers and not go in very much detail here but just comment on few numbers on Page 18. Turnover already said the operational EBIT is NOK1.2 billion up from NOK901 million in Q2 2013. We are reporting according to IFRS, which is the main lion share, the adjustment and the fair value adjustment of biological assets. That actually goes up and down with the salmon price and the fish you have in the ocean towards the end of each quarter and when the salmon price goes down, this is a big part of that picture. And in reality it does not have any cash effect, but this is the way it’s technically accounted for.

Non-operational items, there is negative $168 million in this quarter. That is the provision taken for the fine that was given us by the EU in regards to competition. It’s not a ruling. So this will be appealed and taken into the court system to get the final saying on -- or final sentence on this fine. But we have made provision for that in the accounts.

Underlying earnings per share at NOK2.05 per share and compared to NOK1.51 2013; net cash flow per share at NOK5 compared to NOK1.64 in Q2 2013. The return on capital employed at 23.9% for this quarter and our target there is 12% over the cycle. So we are achieving well above our target in this quarter.

We then go into our financial position and look at balance sheet or short term of the balance sheet in Page 19. Total assets is up from NOK26 million to NOK31 million in this quarter, down a little bit from the end of the year and that has to do with -- that we are down in terms of biomass in a normal cycle in this quarter. And the increase in the balance sheet is -- the big line of the increase is because the inclusion of Morpol into the balance sheet.

And if we look at the net interest bearing debt over equity -- we are at 48.3% and less than our target of 50%. Then shortly into cash flow on Page 20, in the beginning of the period we had a net interest bearing debt of NOK7.5 billion. Operational EBITDA was at NOK1.4 billion plus and I will not go into all the post there but we ended the period here at close to NOK7 billion in net interest bearing debt, short of in our target of interest bearing debt is NOK7.5 billion. And that also have an impact in terms of dividend. As already stated, we pay out NOK1 per share or NOK410 million in the dividend for this quarter, which will bring us back up to the targeted net interest bearing debt level.

Cash flow guidance going forward, we as I said are now at the low level in biomass especially that’s in the Norwegian Scottish operation. So there will be requirements for the seasonal buildup. Some organic growth in farming in Scotland and Canada and some requirements in terms of starting the operation in the feed plant, meaning that we are going away from 60 days feed credit among external feed producers and starting to and also buying some raw materials. That has an effect on the working capital buildup in this period.

CapEx is guided at NOK1.7 billion, NOK1 billion in maintenance, NOK500 million into structural investments, that is for the most part hatcheries and small plants and then NOK200 million into the feed plant. Most of that was taken off -- the feed plant was taken last year and so far this year.

In terms of interest expense, it’s around NOK360 million and we have new finances in place and we see a cut here in the run rate of NOK300 million in terms of interest cost going forward. And then into the quarterly dividend, no point in repeating that. We have a new finance in place and very flexible and good financing for the Company, new loan agreements with the DNB, Nordea, Rabobank and ABN AMRO that has a maturity in Q4 2019 and the facilities EUR475 million. There is basically only one covenant there and that’s a 35% equity ratio and in addition to that, we are agreed to have an option to increase the facility by EUR425 million. If there are needs and we see good potential acquisition candidates, we can react quickly.

In terms of the total financing package of Marine Harvest, there we have two convertible bonds in addition and one bond issued in February 2013 and you can see the different sets of both interest rate and the conversion price in regards to this slide.

We then go into the supply development going forward. Supply development in Q2 2014, as already stated 16% increase in supply and you can see Norway increasing with 15%, Chile with 26.9% compared to Q2 2013, Scotland is up to 18.4%, some went down in supply from North America, meaning West Coast and East Coast of Canada and East Coast there is some in Canada and some in U.S.

Faroe Islands up 9.3% and then the rest are smaller changes in terms of absolute volume. So this is basically a result from optimal winter production cycle in Norway and somewhat better conditions in Chile in terms of biology and we see also improved growth in yield per smolt in Chilean operations.

In terms of the reference price and the development, we’ve been into that to certain extent. If you look at the table there you will see that the Norwegian volume in euros in the European market was down 12%. The fish into the U.S. market from Chile negative 1.3% and the North American volume down 2.5%. And this is on the back of 16% global supply growth. So I think that speaks for itself and we can talk about the very strong demand for salmon, basically globally stronger here in U.S. than in other markets but still strong demand worldwide.

We then look at where the fish has been sold and how the different markets are developing. We see the feed grew by 12.5%. We see strong growth numbers in Brazil, in Asia, in general and markets going down in this quarter and this is before the ban was the Russia with the slight decrease and Ukraine with their problematic situation also being quite a lot down this market. Other than that, pretty strong markets for salmon.

To go into the Russian ban and the Russian sanction on salmon from Norway, Scotland and Canada we have few comments to that on Page 26. And there you can see the Russian market from second half of 2013 until the first half of 2014, so one year period, and where the fish came from and origins. So we can see a total market there up 139,000 ton, 7% of world market in that period; 100,000 ton supplied from Norway, 22,000 ton from Chile and which are obviously the main suppliers here. They have a small operation in Russia in Murmansk, that is yielding around 10,000 ton in this period.

The short term here, we have seen price decrease on Norwegian salmon. It’s fell significant when the ban was imposed and then it stabilized and slightly going up since that time and the spot level is in the area of around NOK30 - NOK31 per kilo.

This will lead to a redistribution of the how fish close in the marketplace. Faroe Islands and Chile, not being impacted of the ban are expected to sell more fish into Russia, leaving open other markets for Norwegian, Scottish and Canadian salmon.

We think there will be short term turbulence and we see that in the first few weeks but its already stabilizing and we are finding routes and logistic ways from Chile and Faroe Islands into the Russian market, making sure that Russian customers get salmon. This is going on in a good way and in the medium and long term this will not be a major problem for the salmon market.

If you then look at industry supply outlook on Page 27, we expect that we will see a growth in 2014, compared to 2013 in the range of 7% to 10%. So all in all, this should give lower price in 2014, compared to 2013. We’ve seen very strong demand and so far this year have achieved good prices and then obviously the future will speak for itself and we will not predict prices going forward. But we can see a short term turbulence in the Russian situation then stabilizing and the market will continue to function more in a normal way going forward. In the very near future, in Q3 we see a pressure in the marketplace, a growth between 6% and 12% high and low range and this should lead to somewhat pressure on prices as we speak; and then a lower growth in Q4 between 1% and 7% which should indicate better market conditions in the fourth quarter for salmon.

Kontali has expected a growth of 3% in 2015 and this include a change in regulations made by the Norwegian government, where they have put in place a role in average MAB in the short period of time from date until April 1st to give some flexibility in regards to the Russian situation.

Our own volume guidance, we are guiding down Norway by 10,000 ton from 264,000 ton to 254,000 ton. We are increasing our guidance in Chile by 7,000 tons; in total going down from previous guidance of 417,000 tons to 414,000 tons. So not major change in the total volume from Marine Harvest.

If we then go into the outlook session, already stated but there will be a tight market balance now in the medium and in the long term and some uncertainty in regards to market turbulence and in regards to the Russia situation and the sanctions there in the near future. We are fairly well protected with very good contract coverage in the second half of 2014, which is on the positive side based on the previous note.

Then we are very happy for the Norwegian government that has stated that they will lead future growth to sustainability targets or biological indicators and that is the right signal to send because if we can improve on the biology, we will be allowed to grow at the production and that for the long term is very much needed to have a sustainable operation going forward.

We expect stronger performance in the new unit, Marine Harvest consumer products, the combination of VAP and Morpol; especially Morpol we’ll see a better result for in the second half. Marine Harvest is continuously working on trying to get a more consolidated industry, both in Norway and Chile, and as stated before the dividend will be paid out and equals NOK1 per share for this quarter.

Moderator, I think then we’ll say thank you for this presentation and open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will now take our first question from Gianmarco Bonacina from Equita. Please go ahead your line is open.

Gianmarco Bonacina - Equita

Few questions if I may. The first one is about cost. You mentioned in your report that you expect increasing the cost going forward because of the challenging biology, especially in Norway but then at the same time you mentioned this is true for the sector but while for your Company you expect actually the cost to improve little bit. So if you can explain how this let’s say more difficult biological situation will actually impact your own Company? Second question is what will be the impact or how you will manage the temporary increase in the biomass, which the government gave to the sector until next year? If I understood correctly you will basically use it to just postpone the harvest or you will actually grow more the biomass? And the last one is about the feed plant. I understand that you are looking at new areas to basically start a new factory. What will be the trigger not to go ahead with the decision and what will make you, say stop this process?

Alf-Helge Aarskog

Yes. First in regards to the report and as you mentioned there is a section that says that the biological situation will lead to cost increase. We expect the cost for Marine Harvest to go down first half or second half compared to first half. We had quite high cost in the first half. But there is a slight cost increase compared to what we saw in 2013.

To be frank, we had expected even a better cost improvement in the second half and what we will see and we will see a slightly cost reduction compared to today’s level and that has to do with the biological situation and the temperature profile we’ve seen in mostly the southern part of Norway in the summer of 2014.

The next question was the question on the new regulation and how we will handle that. In Marine Harvest we might use the flexibilities to some extent but we don’t see many areas where we can use it because the biological situation is not in such a stage that it is defendable to prolong the cycle. The fish needs to get out of the ocean and get harvested because of the sea lice situation and we will not keep it longer in the ocean than necessary.

However, there are small feed areas in Norway where we have good biological condition. We do not have sea lice and we might there if needed use some flexibility. But the main rule in Marine Harvest will be to continue as before, follow our plans and get the fish into the market as planned.

In terms of the third question and the feed plant in new areas, that is correct. We have been looking at new areas and we’ll be looking at new areas this fall. But the first priority is to get the first plant up and working to capacity and really fund or figure out all the quirks in that plant first and then start measuring and see how well we are in fact performing in this division. We will early as discussed a second plant in the first half of 2015 and I expect the decision to be made in somewhere around towards the end of the first half, beginning of the second half of 2013. What would trigger a decision that not to do this, I will say it is fairly completely and does not get the first plant to work, we will postpone and make sure that the first plant is working good and the feed is working well before we decide to build a second plant.

So I guess in short that answers your question.

Operator

Thank you (Operator Instructions). There are no further questions at this time.

Alf-Helge Aarskog

Thank you very much for listening in to the presentation. And we will be back in October with our third quarter presentation. Thank you.

Operator

Thank you. That concludes this conference call. Thank you for your participation ladies and gentlemen. You may now disconnect.

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