Saputo's (SAPIF) CEO Lino Saputo on Q3 2016 Results - Earnings Call Transcript

| About: Saputo Inc. (SAPIF)

Saputo Inc. (OTCPK:SAPIF) Q3 2016 Earnings Conference Call February 4, 2016 2:30 PM ET

Executives

Sandy Vassiadis - Investor Relations

Lino Saputo - Chief Executive Officer and Vice Chairman

Louis-Philippe Carrière - Chief Financial Officer

Analysts

Irene Nattel - RBC Capital Markets

Mark Petrie - CIBC

Peter Sklar - BMO Capital Markets

Michael Van Aelst - TD Securities

Vishal Shreedhar - National Bank Financial

David Hartley - Credit Suisse Securities

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Fiscal 2016 Third Quarter Results. [Operator Instructions] As a reminder, today’s conference is being recorded, Thursday, February 4, 2016. Now, I will turn the conference over to Lino Saputo Jr. Please go ahead.

Lino Saputo

Thank you very much, Tommy.

Sandy Vassiadis

Good afternoon, everyone and thank you for joining us today. A news release detailing our 2016 third quarter results was issued earlier today and is available on www.saputo.com. This call is being recorded and will be posted on our website for future reference. I’d like to specify that our listeners on the phone and on the Internet as well as journalists are on a listen-only mode. Members of the media are invited to ask their questions by phone after this call.

Before we proceed, please be reminded that some of the statements provided during this call are forward-looking. Such statements are based on assumptions that are subject to risks and uncertainties. Refer to our cautionary statements regarding forward-looking information in our annual report and our quarterly releases and filings. Please treat any forward-looking information with caution as our actual results could differ materially. We do not accept any obligation to update this information except as required under securities laws.

Mr. Lino Saputo, Jr., our Chief Executive Officer and Vice Chairman of the Board, will begin this conference by providing his brief overview of the quarter’s key highlights, after which Lino A. Saputo, Jr. and Mr. Louis-Philippe Carrière, our Chief Financial Officer, will then proceed to answer your questions.

Lino Saputo

Thank you, Sandy, and good afternoon to you all. I am very pleased with our third quarter results. We have shown growth in net earnings, in EBITDA and in revenues. These results clearly demonstrate we are able to adjust the headwinds and we remain focused on growing our business responsibly.

Our divisional structure allows us to have well-balanced operations in countries where we operate and provides the stability for every division to effectively control their own destiny. In Canada, EBITDA increased mainly due to lower ingredient costs as well as improvements in warehousing and logistics. The division also benefited from higher sales volumes and a favorable product mix. Additionally, Woolwich, which we acquired last October, had a positive impact on revenues and on EBITDA in Canada and in the U.S.

In the fourth quarter, we will focus on continuing the integration of the Woolwich operations. As for the U.S. sector, fiscal 2016 continues to be a solid year. Both dairy foods and cheese divisions have increased sales volumes and found operational efficiencies while controlling cost. The U.S. divisions will continue to focus on possible synergies stemming from its national manufacturing and distribution footprint and will capitalize on investments that enable future growth. Outside North America, international cheese and dairy ingredient markets continue to put downward pressure on the international sector’s profitability. And these prices are anticipated to remain low throughout the first half of fiscal 2017.

Notwithstanding, we will continue to focus on controlling cost and increasing efficiencies, while growing sales volumes to strengthen our market presence. I remain confident about the long-term prospects for the dairy industry. We have strong people and a developed infrastructure to further expand our presence both domestically and globally. Over the years, our team has proven, we stand together. And through our disciplined approach and continued commitment, we will capitalize on growing markets and evolving trends to meet our customers and consumers’ requirements.

I am proud of what we have accomplished and we will continue to strive to be the best in our field with the goal of becoming yet bigger, better and stronger. And on that note, I now open the floor to your questions. Tommy?

Question-and-Answer Session

Operator

Thank you very much. [Operator Instructions] And we will perceive our first question from the line of Irene Nattel with RBC Capital Markets. Go ahead.

Irene Nattel

Thanks and good afternoon, everyone. Really nice to see the continued sequential improvement in performance across all three segments. Wondering, if you could just walk us through what the key factors are and how we should be thinking about continued evolution of progress as we go forward over the next few quarters?

Lino Saputo

So from a global perspective, within every single one of our divisions, Irene, we are resilient in finding ways to lower our cost from a manufacturing standpoint. That’s part of our DNA as you know. It is something that we never feel like we get to the end of the run with. It’s something that is a continuous progressive improvement that we make at each level. We do have some great initiatives in each one of the divisions that help us get to the end result a little bit quicker. Things like volumes. We increase volumes in all of our divisions, almost in all of our categories. And when you have higher volumes then it’s easier, it helps us to absorb some of the overhead. And those are things that our guys work on every single day trying to find new ways to find new customers in different categories of products and we were successful in Canada and in the U.S., both in the dairy foods and in the cheese side at growing our volumes. But it goes beyond that. I think in terms of our ingredients usage, our guys have always been very creative in terms of trying to find the highest quality solids at the lowest cost and incorporate them in our make process. And so again it’s a lot more of the same story that Saputo has been saying now 18 years, that we have been public. We are looking for opportunities and avenues to be a high-quality low-cost producer and we don’t ever think that we get to the end game there.

Irene Nattel

Thank you, Lino. And can you just talk a little bit about where you are seeing the best volume growth? And if you could quantify the volume growth and also in your view, are you gaining share in your key categories?

Lino Saputo

Yes, so let me speak about Canada first, which you recognize is a stable to declining market. Overall, in Canada both on the fluid and on the cheese combined, we are up about, I’d say up we are about 4% over last year – so, rather 2% over last year. So, we have made some progress when the overall industry is declining. On the dairy food side, we are closer to 4% growth. And on the cheese side in the U.S., in this quarter alone, we are up 9% in our overall growth. So, we made a lot of strides forward in terms of being able to capture new clients or perhaps even grow with existing clients.

Irene Nattel

That’s great. Thank you. And then just finally, can you talk a little bit about the M&A environment and whether they would be current challenging pricing backdrop isn’t that helping the pipeline of potential acquisitions?

Lino Saputo

M&A, we are always actively looking at potential platforms that would add to our existing platforms, platforms that would make us bigger, better and stronger as I have always said. And as we get involved in some of those files, we recognized that perhaps it might not be their synergistic value that we are looking for or perhaps the pricing might be a little bit too high. We have materialized some acquisitions last year albeit small, but strategic. I find that, for the Canadian platform, Woolwich was a good acquisition for the Australian platform. The Everyday Cheese business was very strategic. But none of those really moved the needle. Those bigger acquisitions do exist, but we need to be patient. We need to understand the impact that they would have for us and we need to pay the right value for them. So, I am saying to you, Irene, that the runway still is very, very long. I have great confidence that we will materialize acquisitions as we move forward, but again, we will treat every file with a discipline we have always had.

Irene Nattel

That’s great. Thank you.

Operator

Thank you very much. We will get to our next question from the line of Mark Petrie with CIBC. Go ahead.

Mark Petrie

Hi, good afternoon. I just wanted to come back to the volume trends and wondering if you could talk specifically about each market by channel? And if there is any sort of interesting outperformance or underperformance relative to the numbers you gave us by channel and especially I guess in the U.S.?

Lino Saputo

Okay. So, specifically in the U.S., we are finding that all of our channels are quite positive. We are finding the retail channel, especially if I look at the value of our fixed priced products, specifically spring cheese in a low market it’s favorable. And we have had some great growth there. But not exclusive through the retail, I think on the food service side, both in dairy foods and on the cheese side, we have grown our commodity type products as well. So we are finding some pretty good momentum, both at retail and specialty. Where we are finding a little bit of a challenge, is in the industrial business, which is more competitive business, where you have got one customer that takes a large volume of product very, very easy price sensitive type orientation in that channel. We defend ourselves extremely well. But really the growth that we have seen both on the cheese USA side and on the dairy food side has been retail and on the food service side, with some of the wins we had over the course of last quarter.

Mark Petrie

Okay. And anything interesting in Canada?

Lino Saputo

Canada again, you look at the fluid milk market, which is again flat or declining. We have been able through the banners that were connected with we have been able to grow some of our market share here. So again overall, we are about 1.5%, 2% ahead of last year on the fluid site when the industry is declining. And on the cheese said, I would say we would probably be somewhere around 4% growth over last year.

Mark Petrie

Okay, that’s helpful. Thanks. And then on the international, I mean obviously, continues to be pressured versus last year, just on the price side, but you did improve profitability pretty nicely from Q1 and Q2, what are the drivers there and how should we think about that going forward given your comments about expecting international dairy prices to remain lower for a little bit longer?

Lino Saputo

Yes. So, that’s a good point to start. So the international pricing is going to be challenged for, I would say at least until the end of this calendar year. That’s the expectation that most of the economists are giving us in the dairy industry. Now, we are fortunate enough in both platforms in Argentina and in Australia, we have a very strong domestic presence. And part of the probability that we are seeing the upswings that we are seeing in our profitability are coming from the domestic market, part of that is coming from some assistance on the foreign exchange, both on the peso and on the Australian dollar. But by and large, I would say lot of that upswing is also coming from operational efficiencies, just doing things a little bit better than we did the day before. So a combination of those three elements that help us drive profitability to the international channel, even though there hasn’t been much improvement or much recovery in the pricing.

Mark Petrie

And should we look at the Q3 results as kind of a run rate in this pricing environment or do you think there is further opportunity?

Lino Saputo

Well, look Mark, we don’t provide any guidance at all. It’s not that – it’s not been a habit of Saputo, but I can tell that we are always striving to do better. The markets I think will remain stable. I don’t think they are going to decline on the international side. I think domestically things can get better. So I am still very optimistic about the dairy industry, not only in our domestic businesses, but also internationally.

Mark Petrie

Okay, that’s helpful. Thank you very much.

Lino Saputo

Alright.

Operator

Thank you. We will get to our next question from the line of Peter Sklar with BMO Capital Markets. Go ahead.

Peter Sklar

Thanks Lino. I think it’s all been covered by the previous question, expect that one little picky question. In your outlook section this quarter you dropped some language, so in the previous quarter with respect to Argentina, you had language that you are looking for additional international markets for Argentina and I noticed you drop that phrase in this quarter’s guidance, should we read anything into that?

Lino Saputo

No. Look we – from three of our operating platforms, we are selling into the international markets and we are selling it to 40, 50 different countries around the world. And the three platforms will be the USA, Argentina and Australia. Now we provide a multitude of products with quite a bit of flexibility in each of those divisions for our sales teams to go out and try to tackle the best returning market for the platform that can service that product. So we interchange sometimes product and volume from one division to the other. So nothing has changed in terms of our go-to-market approach. Since we bought the Australian platform, we have another tool in our belt by which we can go-to-market with. That doesn’t mean that, Argentina is less important. In fact, it’s is as important as it’s ever been before, so I wouldn’t read much into that Peter.

Peter Sklar

Okay. And then just lastly, in terms of your export of dairy products from one in blow into the China market, are you able to characterize the China market is still declining, stable or growing, do have any insights as to where you are at in that market?

Lino Saputo

Yes. So, China is still growing. So I don’t want to give the impression that China has fallen off the cliff here, because it hasn’t. The only thing is that, historically 2 years to 3 years ago, everybody was gearing up for 12%, 13%, 14% growth in China. And they have built production and function of the anticipated growth. The reality is China is growing at a rate of 4%, 5%, still growing. But a big gap between what is currently happening in terms of growth and what was expected. And so right now, there is too much milk in the system. That milk in my opinion is starting to wean off. In fact, I have seen some press clippings, where there are co-ops in Europe that are offering bonuses for reduction of milk production. I have read also in Oceania that there are some of the co-ops that are trying to temper the amount of milk that their farmers are producing only because the economics don’t make sense. So I think it’s a matter of time before there is a natural balance between the amount of solids that are produced and the still growing demand in the emerging markets.

Peter Sklar

And are you still locked out of the Russian market?

Lino Saputo

While the Russian market, two reasons. Yes, we are locked out. One, there are some embargoes from certain countries. And tow, the Russian ruble is – has been devalued. And so their purchasing power has gone down. So even if there would be no embargo, the cost of dairy solids at U.S. prices would be prohibitive I think right now.

Peter Sklar

Okay. Thank you.

Lino Saputo

Alright. Thank you, Peter.

Operator

Thank you very much. [Operator Instructions] And our next question is from the line of Michael Van Aelst with TD Securities. Go ahead.

Michael Van Aelst

Hi, good afternoon and congratulations on the quarter.

Lino Saputo

Thank you, Michael.

Michael Van Aelst

A few questions, the 9% growth in the cheese in the U.S. and 4% in Canada, both stick out as extremely higher. And I know you gave us a bit of a color on that. But can you give us a sense as to whether this is business that’s kind of contracted out and is sustainable or is there any kind of temporary one-time nature to any of it?

Lino Saputo

There is a portion of that, that is following the growth of some of our customers and I am sure, you have read as much as I have, whether it would be at the food service level or at the quick service level. You have got some of the banners that are winning and some of them that are not winning as great. While we are fortune enough to be with the banners that are growing in Canada as well as in the United States, but then there also had been some great wins for us in terms of getting new contracts or new customers. So I would say that, I don’t know if the percentage growth is sustainable, but I think the volume that we are processing and delivering is sustainable.

Michael Van Aelst

And are those new customers on both sides of the border?

Lino Saputo

We do have new customers on both sides of the border or perhaps same customers, but new markets.

Michael Van Aelst

Okay. And then if we look at – if you look at the competitive situation in Canada, the raw milk prices are going increase, what 2%, I think this over 2% in February, to what degree do you think you are going to be able to past that through?

Lino Saputo

While we are optimistic that we are going to pass it 100% through and again, this is like every other exercise we have gone through in the past. Our intention is to factor that 1.8% to 2% increase into our cost models and roll that out with our customers. And this is what’s happening currently right now.

Michael Van Aelst

Okay, great. And then and your DC in Montreal, it looks like you have made some meaningful progress in getting the costs down there, where do you see stand relative to the end state that you want to be at?

Lino Saputo

Well, I am very happy to report that our order fill rates are back to our historical levels. So that was really key for us. We needed to make sure that our customers had the product when they needed the product, so very, very happy about that. But we still have a few more expenses in the system than what we would like. As we announced at the beginning of this fiscal year, it probably would be 2 years out from the beginning of last fiscal year before we get to our sweet spot. So, I think we still have maybe a year and a quarter before we get there.

Michael Van Aelst

Okay, great. Thanks very much.

Lino Saputo

Alright.

Operator

Thank you. We will go to our next question from the line of Vishal Shreedhar with National Bank Financial. Go ahead.

Vishal Shreedhar

Yes, thanks for taking my questions. Just on the balance sheet, fairly solid, I think it’s the strongest than it’s been in at least a few years. Some may consider it to be overcapitalized given the durability of your business model. So, aside from seeking acquisitions, which I think you said you constantly do, does management have any other thoughts on optimizing the balance sheet maybe being more aggressive with their share repurchases or other thoughts?

Louis-Philippe Carrière

I would say, it’s certainly a first priority. Again, it’s essentially to align our cash through essentially acquisition. And we said that in the past also that for any excess cash that we certainly can direct that to the repurchase program that fits in place through the MCIV and essentially that’s the way that we do manage that to say that we are going to do A for B, certainly A for whatever an acquisitions tomorrow, it’s certainly their first priority or and about maintaining and growing our dividend as we did over the past 17 years.

Vishal Shreedhar

Okay, thanks for that. And just moving on to the SG&A rates, SG&A rates have been ticking up year-over-year notwithstanding the efficiency initiatives that Saputo has been making progress with. Just wondering on a year-over-year basis, is there any way to look at the SG&A rate in terms of what’s driving that, is that the initiatives you have been talking about in Canada?

Louis-Philippe Carrière

It’s only an issue or two as Lino was mentioning in term of – in Canada as well as in the U.S. essentially that are getting to that solution yet.

Vishal Shreedhar

So, is that a new run-rate level of SG&A rate or should we think as some of these DC initiatives stayed away that the rate should go back down to historical levels?

Louis-Philippe Carrière

Look, we are not giving any guidance at the end of the day and we are trying to improve year-over-year.

Vishal Shreedhar

Okay, thanks for that color. Appreciate it.

Operator

Thank you very much. We will get to our next question from the line of David Hartley with Credit Suisse Securities. Go ahead.

David Hartley

Thanks. Good afternoon. Just question on the breakdown of international sales, can you give us some color in terms of whether or not you are shipping the finished cheese product, WMP and other products like that and how that’s kind of changing?

Lino Saputo

Yes. So, I won’t it break it down, because again for competitive reasons, we avoid talking about volumes. But I would say that we sell a multitude of products into the emerging markets and most of which are long shelf life products. So, we do sell powders. And those powders could be in the form of primary product like whole milk powder or skim milk powder or it could be byproducts like WPC, whether it’s WPC AD35, whey lactose or DPW. And we also have very strong markets on the cheese side and we sell into the Pacific Rim and other countries into the Middle East. We shipped product from Argentina into Brazil. And from the U.S., we are shipping out into Korea and other countries. So, it is a mix of primary product, which is milk side. It is a mix of byproducts, which will be on the whey side. But I hesitate to breakout those numbers for you really more for competitive reasons.

David Hartley

Okay, that’s fair. Just want to get an idea there. And as you look at it from your international platforms, U.S. Argentina and Australia, let me focus on Australia. So, Australia have a strong retail presence and domestic presence. Do you see that kind of declining over time as you move towards international markets or do you see a lot more opportunity for consolidation in that market?

Lino Saputo

I think there still is some opportunity for consolidation in the domestic market. In fact, I am not sure if we announced this in the last quarter, but we have one of our key executives from our Canadian team in marketing that moved his family to Australia to develop the brands and the domestic market in Austria. So, we are fully committed to the Australian market. Now having said that, we are also very ambitious when it comes to collecting milk, we have picked up more milk this year than we had last year. And that means that without having to take volume away from domestic, we can have more volume for the international. Both of our platforms, actually all three of our platforms have quite a bit of flexibility built into them, where we can swing our sales domestic to international and back the other way by about 60-40. So we can do 60% domestic and 40% international. And the flexibility is built in, so that we can go 60% international and 40% domestic, depending on where the best revenue is for us. But in a perfect world, what we like is to have more milk. So we don’t have to short anyone of those two markets and continue to build on both.

David Hartley

Okay. And talk this week about Burra Foods [ph] being up for share, is that something confirm and can you talk anything about that situation at all?

Lino Saputo

Well, I have read the same article you have read. So that’s the best as much I can say on that.

David Hartley

You have only read articles about it?

Lino Saputo

Well, we read articles and the industry is very small, so we bump into different people. So I have probably chatted about it to some people at some time. But I can’t confirm or deny anything.

David Hartley

I was just wondering if you are reading files on your desk and so. Just one last question, just on minimum pricing, when we think about Canada, is it going to be changes – has there been changes in terms of minimum milk or cheese pricing at retail or elsewhere in the country and could you give some thoughts on that?

Lino Saputo

Yes. So the - I would start with the TPP. There would be a lot more movement in the dairy industry in terms of regulations changes. TPP, as far as I know right now still, it’s still in the ratification. I think Canada signed a document today regarding TPP that they are prepared to ratify it. But it’s going to be a 2-year program – 2-year process before anything gets done. So nothing really changed with respect to regulations through the TPP discussions, nor did they change through the CTA regulations. So the regulations are slow-moving and not much happens and that’s the nature of our system. So there is no changes to minimum pricing either.

David Hartley

Okay. Thanks a lot Lino.

Lino Saputo

Thank you.

Operator

Thank you very much. Mr. Saputo, we have no further questions on the line, I will turn it back to you.

Lino Saputo

Thank you very much, Tommy.

Sandy Vassiadis

We thank you for taking part in this conference call. We hope you will join us for the presentation of our 2016 fourth quarter and year end results on June 2. Have a nice day.

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