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Sadia SA (NYSE:sda-old)

Q2 2007 Earnings Call

July 27, 2007, 8:30 AM ET

Executives

Welson Teixeira Jr., - CFO, Director of IR

Christiane Assis - Manager, IR

Analysts

Alexander Roberts - Santander Central Hispano

TRANSCRIPT SPONSOR
Wall Street Breakfast

Operator

Good morning, ladies and gentlemen, and welcome to Sadia's conference call to discuss the second quarter 2007 results. I would like to mention that a slide presentation is available on the company's website. That's www.sadia.com under the Investor Relations section.

Before proceeding, let me mention that forward looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of 1995. Actual performance could differ materially from those anticipated in any forward looking comments as a result of macroeconomic conditions, market risks and other factors.

With us today in Sao Paulo are Mr. Welson Teixeira Jr. Investor Relations Director and Ms. Christiane Assis, Investor Relations Manager. First, Mr. Teixeira will comment on the company's second quarter 2007 results. Afterwards, the executives will have a question and answer session.

It is now my pleasure to turn the call over to him. Mr. Teixeira you may now begin.

Welson Teixeira Jr., - Chief Financial Officer, Director of Investor Relations

Okay. I'll start talking about the highlights of the second quarter 2007. We had an increase in sales in both domestic and the export markets and the recovery of the pork prices in the export market to the levels prior to the avian crises in Europe, leading to a share of 47% in export markets and the share of 53% in the domestic market. And more in line with the company's strategy to keeping those markets on a 50/50 basis.

In the second quarter 2007, gross operational revenues grew 30% over the same period in 2006, driven by the sales of the processed products in the domestic market and the export into the export markets. And volumes sold grew 12% between the second quarter of 2007 and the second quarter of 2006. Growth in the domestic market rose by 1.2% in the second quarter of 2007, in relation to the same period in 2006.

Revenues from the market in terms advanced 12% in the period signaling a growth in the demand for processed products. In the export markets average price continued their road to recovery during the second quarter 2007, in relation to the same period of the last year, when performance was severely hurt by the avian influenza and the Russian embargo to the Brazilian pork. In the second quarter 2007 the export volume grew 20% in relation to the same period in 2006. Sadia feels that its continued commitment with the growth and the expectation add to global annual sales in the oncoming five years. And the board of directors had approved an investment plan of R$2 billion for the next 12… for the next 18 months. Distributed as follows: R$720 million to the processed products segment and R$640 million to the Lucas do Rio Verde brands and R$130 million to the Beef segment. And another R$510 million in values expansion plans, IT infrastructure projects and the breeding stock. The investment in the processed products segment will be distributed to the refrigerated products, to the domestic market and the baked goods, breaded products, to both markets besides other non-meat products.

Lucas do Rio Verde investments includes the construction of the Poultry and pork slaughterhouses, a feed and a pork processing plant.

As for the Beef segments Sadia plans to slaughter 6,000 heads per day by 2009. In order to do so, the company's expanding the slaughtering factory at Várzea Grande from 1000 heads a day to 2000 heads a day. And by the beginning of 2008, adding a new plant with a larger capacity of 2000 heads a day for the same year.

Now Christiane will talk more about the other figures.

Christiane Assis - Manager, Investor Relations

Good morning to all. I'd like to follow the presentation which is available on our website.

First slide. Gross operating revenues increased 26.6% during the period with the break down of 53% to the domestic market and 47% to the export market as Welson already mentioned before, more in line with the company's strategy of reaching a 50/50 percent breakdown.

In terms of highlights the domestic market grew 18.5% in terms of revenues while the export market grew 45% from second quarter of '07 in relation to second quarter '06. Net operating revenue grew 31.4%, which translates to an EBITDA of R$229 million, and an increase of 236%.

Next slide. The total gross operating revenues of Sadia reached R$4.5 billion for the semester and we see a relative increase in the Beef segment from 3% to 4%. Processed products continues to be the large number in terms of our product mix, which helps to mitigate sanitary risks as well as presents better margins.

Next slide. The domestic market increased 16% in terms of gross operating revenues and again, we see processed products as the largest component with 80%.

Next slide. Export market grew 41% in terms of revenues. Beef, increasing in relative terms and absolute terms from 7% to 8%, while we see a decrease in Poultry from 71% of our total pie to 69%.

Next slide. Our exports by region continue to be well distributed in terms of geographic distribution with 25% to Europe and 23% to the Middle East.

Next slide. Sales Volumes. It's important to mention here that while the total sales volumes for the domestic market was 1.3%, the big increase we can see in processed products, which was 13.8% and the decrease in Poultry of 40% is easily explained by the redirection of the production to the export market so that in volumes… so that you see in volumes of Poultry to the export market growing 12.5%. Okay. In terms of the export market you also see 56% increase in terms of processed products which I am going to explain a little bit further.

In terms of sales revenues, domestic market 18.5%, export markets, 45%.

Next slide. So that a total change in terms of volumes for the company is 12.2% in terms of volumes and 29.7% in terms of revenues.

Next slide. In terms of average prices, in the domestic market. On a quarter-by-quarter basis you see a 3% increase in the processed products, which again is 80% of our total revenues in the domestic market, and then you see a recovery in the Poultry and Pork prices in Brazil as well due to the redirection of these commodities to the export markets.

In terms of average price export markets, when you take into consideration the currency devaluation of 9.4% of the dollar in relation to the Real, when you see this, when you analyze the processed products 50% falling in terms of Real terms, that is only a 6% fall in terms of dollar terms. This fall in prices can also be explained by a little bit, a change in mix and some products being sold to Venezuela, which have a smaller price.

The Poultry price, when you see an increase of 25% in Reals, represents almost a 35% increase in terms of dollars, which puts the Poultry prices back in line with the average prices that we saw in 2005 pre-avian flu crises in Europe.

In terms of pork, when we take into consideration the devaluation, it's almost an increase of 6% in dollar terms.

And in Beef, when we take into consideration as well, the devaluation of the dollar, this will present almost a 2% in terms of Beef.

Next slide. Statement of income, for those following the webcast we are changing the slide on our site. This might be wrong if you are following the webcast. Okay.

Please look at the gross profits. The gross margins for this quarter, 25.7% which is in line with our expectations due to the higher prices of grain in relation to the last year. When we look at our component of grains, soy and corn in relation to last year we were expecting a rise of 20% in our grain prices. So this is reflected here in our gross profit.

In relation to the sales expenses, 17.4% which historically is in line with our average numbers. And EBITDA margin of 11.4% for the quarter.

Next slide. So again our gross margin 25.7%, pretty much in line with what we had expected for this second quarter, and again pressured by the grain prices.

Next slide. Sales expenses again 17.4% and there was some influence here in terms of marketing expenses because of our campaign for the Pan American games that are being held now in Rio and as well as some increase in terms of logistics.

Next slide. Net income reached a R$109 million for a net margin of 5.4%.

Next slide. EBITDA reaching for the second quarter R$229 million and a margin of 11.4%, pretty much in line with what we have been announcing for the year.

Next slide. Capital expenditures, R$176 million. And as Welson mentioned before, we will see this number increasing during the next quarters, the next semesters, towards reaching the R$2 billion for the next 18 months. And in the next slide, we pretty much break this down. And again, this was mentioned before, R$720 million for the processed products line and these processed products are going to be towards the domestic market, as well as the export markets. The R$640 million in the Lucas do Rio Verde plant and here we are going to have a Poultry, a Pork, a feed plant as well as a processed products of pork products. R$130 million in our Beef capacity and pretty much R$30 million alone this year to increase the capacity of 1,000 heads per day in our Várzea Grande unit to 2,000 heads per day by the beginning of next year. And we have R$100 million next year, which we will disclose shortly, where we will be investing the other R$100 million. We have R$510 million here, which is going to contemplate our Russia plant, which is in the final terms of investment. Other expansions in Concórdia and Brasilia we have some infrastructure, investments in IT, as well as breeding stocks.

In terms of financial indebtedness, we are pretty much in line with what we believe. Net debt to EBITDA is currently 1.3 times EBITDA, okay. Net debt to EBITDA. We also have recently approved a new indebtedness plan, which basically contemplates that Sadia will necessarily have to be between two ranges. The upper range being two times EBITDA and the lower range one time EBITDA. So, net debt will necessarily have to fluctuate in between these ranges, which gives the executives more flexibility to approve investment plans.

Next slide. In terms of market share, we see frozen processed products increasing from the last semester. Pizza increasing to 32.7% of market share, Margarine to 40% of market share. And refrigerated processed products to 30.2% of market share. We continue to be ranked number one in all these categories, which I just mentioned. This year, we have had until now 11 new product releases. A lot of them contemplated in terms of special products directly towards the Pan American Games.

To finalize our presentation, we continue to be actively traded both on the New York Stock Exchange with the $4 million per day average and on the Brazilian Stock Exchange with R$23 million day average. Foreign investors continued to be the largest portion of our investors with 55%.

And at this moment, I would like to open up for questions. Thank you.

Question and Answer

Operator

Thank you. Ladies and gentlemen, we now begin the question-and-answer session. [Operator Instructions].

Our first question comes from Eric Oleman [ph] from ING. Please go ahead.

Unidentified Analyst

Hi, good morning everybody. And congratulations on the good results. My question has to do with your feed prices and hedging policies. Could you just tell us how much of that has been hedged out for 2007 and if any, for 2008? And then just sort of secondarily, on your Beef sector build-out… going to 6,000 heads per day, do you contemplate any sort of M&A activity in that space or is it all going to be organic construction? Thank you.

Christiane Assis - Manager, Investor Relations

Well Eric, in terms of grain, we have been alerting our analysts during the quarter that we still expected some pressure in terms of grains. We saw the highest prices in grains, especially in terms of corn in Brazil… reached the highs in December and January. In terms of Sadia, the reason we see this impact in the second Q still is because there is some delay in terms of, when you stock this and when this actually appears on your COGS line, okay. So, we still did see some impact.

In terms of hedging this risk, we don’t do any hedging in terms Chicago, okay, in terms of financial instruments in Chicago. In terms of Brazil, the market is still too small to hedge this risk, via financial instruments. So that we hedge this risk via stock, if it's physical hedging, okay. When we believe the market is going to go up, we buy more. When we are believe it is going to go down, we basically use what we have in stock, okay. So that moving forward, third Q should have less of an impact of those higher grains prices that we saw in the beginning of the year, okay.

In terms of Beef, as I mentioned, we are currently spending R$30 million to increase our 1,000 heads per day capacity to 2,000 heads per day capacity in Várzea Grande. And as of next year, we plan an additional R$100 million which will either be directed towards an acquisition or construction of an additional plant which will contemplate 2,000 heads per day. In 2009, as Welson mentioned we plan an additional 2,000 heads, so that by the end of 2009, Sadia will reach 6,000 heads per day capacity in Beef. Okay?

Unidentified Analyst

Okay. Thank you.

Christiane Assis - Manager, Investor Relations

Thank you.

Operator

Our next question comes from Alex Roberts from Santandar. Please go ahead.

Alexander Roberts - Santander Central Hispano

Good morning, everybody. I wanted to start out first on the CapEx program, and the announcement of R$ 2 million. If I am doing my math right, I mean I am just trying to kind of figure out what we are looking really for next year, if we stick with the R$950 million, that you guys were talking about including the breeding stock for 2007, it would seem that now we could be looking for total CapEx for ’08 kind of close to the R$1.4 billion mark. And I wanted to kind of first of all confirm it, if that… if that in the ballpark was how you are looking at it between ’07 and ’08?

And the second part of this is really, this is definitely a change to what we have been hearing, and I am wondering the motivation behind the aggressive CapEx for next year. Is it on the processed products and kind of a desire to kind of get that more as a percentage of total sales or is it related to kind of the various expansions in the Lucas build out. If you could give us some color that would be great?

Welson Teixeira Jr., - Chief Financial Officer, Director of Investor Relations

Alex, we already did the investment in 2008 is R$1.4 billion. And we are looking for processed products… their focus being processed products because we believe that the view has a capacity of increasing a lot and we are focused on our broadening to add value for the company

Unidentified Company Representative

As well as… I will just add some additional here. Not only as Welson mentioned, the processed for Brazil but it's also the company's focus to continue its investment in processed towards the export market. So what we always mentioned the breaded, the grilled toward the export market so that if you look at our export volumes, in terms of processed they grew a lot, they grew 56%. Of course, there is a part there which is towards Venezuela. But if you exclude that Venezuela your increase in processed is around 30%, so that we are managing to grow our processed products, our Poultry processed products as well, the Pork processed products in 30%, 35%. Okay. And I guess the other thing that you mentioned was Lucas. Lucas is going to be a Poultry, a pork and a processing unit, okay, so that it is going to produce the raw material that we need in order to process these products.

Alexander Roberts - Santander Central Hispano

And just a clarification on the processed products build-out. Are you seeing kind of equal opportunities in the export market or in the domestics or is the motivation to kind of ramp up the CapEx in processed, more of a function of just trying to get into, just more on the domestic in Brazil?

Christiane Assis - Manager, Investor Relations

Both of them. Both of them. Our revenues in Brazil, they are 80% processed. But we still see a huge opportunity to sell to lower classes as well, okay, so we are ramping up that opportunity, okay. And since the processed is only 11% of our export market we see a lot of opportunity there as well. And it has been the company's focus to increase that segment, okay, which also presents better margins and the company would be free of certain sanitary risks.

Alexander Roberts - Santander Central Hispano

Great, okay now, that’s helpful. And the last question is just on the Russia project. Are you guys on schedule to finish and get actual sales out of this unit in the second half of this year? And what do you think we can kind of be looking for as far as just incremental growth. That would be helpful with any guidance?

Welson Teixeira Jr., - Chief Financial Officer, Director of Investor Relations

Alex, we have a little bit… a little delay in our schedule. But we believe that we will start the production in the first month of the next year. We will… actually informed before that it could happen in this year, but the delay of the constructions, we believe that will happen in the first month of the next year, we'll start to sell from that plant.

Alexander Roberts - Santander Central Hispano

And have you given us a sense of the capacity there or the kind of what the, what kind of size we're talking about in terms of production?

Christiane Assis - Manager, Investor Relations

Sure. Basically the plant at its first moment will have a capacity for 50,000 tons.

Alexander Roberts - Santander Central Hispano

Thank you very much. Thank you.

Christiane Assis - Manager, Investor Relations

Okay.

Operator

[Operator Instructions]

We have a question from Katie Blackhawk from Desky [ph] Capital. Please go ahead.

Unidentified Analyst

Hello. I just had a question on pricing of processed products in the export market. Can you explain the reason for the fall in the quarter, the 6% in dollars, and obviously a larger fall in Reals. It's just that looking at your pricing now, industrialized products are selling at a discount in the export market relative to the domestic market. And both in Q1 and in Q2, in fact that discount's widened out now to $0.18. I just wondered, is that mix issue on the export side or are you trying to push your market share by discounting prices? Thank you.

Christiane Assis - Manager, Investor Relations

Hi, Katie. You're absolutely right, it is a mix issue. If you look at our volume levels, they were up 56%. So a lot of…, not a lot of that, but part of that is explained by a couple of shipments sent to Venezuela, and Venezuela, not necessarily are they the higher margin products. Okay. So, they are the lower margin products. So, anything from sausages to bolognas to margarine, okay. So, within these … this 14.8% in the Reals, and as you mentioned, the 6% fall in dollar terms is mix. If we excluded the impact from Venezuela the 56% increase in volumes would probably read around 30%, and you would not have seen this decrease in average prices.

Unidentified Analyst

So what would have happened to the average prices, they would have been flat year-on-year?

Christiane Assis - Manager, Investor Relations

Probably, yes

Unidentified Analyst

Okay, and what can we expect for that mix going forward, then?

Christiane Assis - Manager, Investor Relations

We do expect the mix in terms of the profits. The Poultry products continue increasing around 20% to 30%. Okay, the company has a large big focus in terms of increasing its processed products towards the export market, so we will see that increase. And Venezuela is a market that … it is a very … it is a case by case. So in one quarter you might see a big sale and maybe in the next quarter you don’t, okay. But in terms of process we will continue to see the sales of Poultry processed products increase through Europe to the Middle East and to Russia.

Unidentified Analyst

Okay --?

Christiane Assis - Manager, Investor Relations

And …

Unidentified Analyst

And this full year guidance for pricing on the export side for processed products specifically, would you say a decline of what, 5% in dollar terms ?

Christiane Assis - Manager, Investor Relations

If we excluded Venezuela, I would say that it's flat to rising, okay. When we include Venezuela, it's probably declining a little bit

Unidentified Analyst

Okay. And can I just check that you are maintaining your guidance in terms of EBITDA margin of 12% to 13%?

Christiane Assis - Manager, Investor Relations

Yes. We still do maintain our annual EBITDA margin 12% to 13%.

Unidentified Analyst

And do you give revenue guidance?

Christiane Assis - Manager, Investor Relations

No, we give volume guidance.

Unidentified Analyst

Okay. That’s great. Thank you very much.

Christiane Assis - Manager, Investor Relations

Okay. Thank you.

Operator

Our next question comes from Mr. Roger Oye with Danish Bank [ph].

Unidentified Analyst

Hi good morning. My question is first on strategic, and growth outside the Brazil. Would you be willing to consider companies in the soybean segment outside Brazil? And how is that strategy to acquire anything for the Brazil, like how would be the strategy, just distribution or focused on certain segment?

And my second question is regarding the debt. I see that you have a very ambitious plan on CapEx and expansion. Are you willing to issue that or even make a capital increase, going forward? Thank you.

Welson Teixeira Jr., - Chief Financial Officer, Director of Investor Relations

Okay. I will start with the second question. We have an internal policy that we invest in the range between one and two EBITDA level. And we believe that the generation of cash in the company's EBITDA will be enough to finance our investments the next years, actually one or two years. But we don’t have any intention to increase the capital at this moment. Regarding the first question, please could you repeat it?

Unidentified Analyst

Okay. If you're willing to make acquisitions outside Brazil, would you consider buying any company in the soybean segment?

Welson Teixeira Jr., - Chief Financial Officer, Director of Investor Relations

No.

Unidentified Analyst

Or if… and if not how… what can we expect in terms, if there is any acquisition target outside Brazil?

Welson Teixeira Jr., - Chief Financial Officer, Director of Investor Relations

It is not our intention to acquire this kind of company, soy, outside of Brazil. Our strategy is to increase our capacity and sales in processed products and distribution in retail, in case of what will substantially help us to distribute our processed products outside of Brazil.

Unidentified Analyst

Okay. Thank you.

Welson Teixeira Jr., - Chief Financial Officer, Director of Investor Relations

Okay.

Operator

[Operator Instructions].

This concludes today’s question and answer session. Mr. Welson, at this time you may proceed with your closing statements.

Welson Teixeira Jr., - Chief Financial Officer, Director of Investor Relations

Thank you for everybody to attend our conference call and… I thank you for everybody.

Operator

That does conclude our Sadia second quarter 2007 earnings results conference for today. Thank you very much for your participation. You may now disconnect.

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