Sanderson Farms F2Q08 (Qtr. End 4/30/08) Earnings Call Transcript

| About: Sanderson Farms, (SAFM)

Sanderson Farms (NASDAQ:SAFM)

F2Q08 Earnings Call

May 22, 2008 10:00 am ET

Executives

Joe Sanderson- Chairman, CEO

Lampkin Butts- President, COO

Mike Cockrell- Treasurer, CFO

Analysts

Farah Oslin- Stephens, Inc.

Ken Zaslow- BMO Capital Markets

Michael Tygen- Cleveland Research

Jeff Linroth- Living it Better

John Kohler- Oppenheimer & Close

Operator

Good morning, and welcome to today’s Sanderson Farms second quarter 2008 conference call. Toda’s call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to Joe Sanderson. Please go ahead sir.

Joe Sanderson

Good morning, and welcome to Sanderson Farms second quarter conference call. Lampkin Butts, our President and COO, and Mike Cockrell our CFO are with me this morning. We issued a news release this morning announcing earnings of $6.2 million, or $.30 per share for our second fiscal quarter of 2008. This compares to net income of $26.9 million, or $1.33 per share during last years second quarter. I will begin the call with some brief comments about general market conditions and the companies operations. I will then turn the call over to Lampkin and Mike for a more detailed account of the quarter.

Before we make any further comments, I will ask Mike to give the cautionary statement regarding forward-looking statements.

Mike Cockrell

Thank you, Joe, and good morning to everyone. This morning’s call will contain forward-looking statements about the business, financial condition, and prospects of the company. The actual performance of the company could differ materially from that indicated by the forward looking statements because of various risks and uncertainties. These risks and uncertainties are described in our most recent annual report on form 10K and in the companies quarter report on form 10Q filed with the SEC in connection with our second fiscal quarter ended April 30th, 2008. That form 10Q was filed with the SEC this morning.

Joe Sanderson

Thank you, Mike. During last years second fiscal quarter we reported that three significant factors drove our financial results. First, markets for all parts of the chicken improved significantly during last years second quarter in response to production cuts put in place in late calendar 2006. Second, we had more pounds of poultry products to leverage into those improving markets than during the previous years second quarter. Finally, our costs for corn and soybean meal were significantly higher last year than the year before.

During this years second fiscal quarter we again had three significant factors driving our financial results. Like last year, our cost for feed grains was significantly higher than last year. Secondly, again like last year, we had more pounds to leverage into the market than the year before. Finally, we operated very well during the quarter, and I congratulate everyone associated with our operations; our managers, employees, and growers, for their focus on our operations, and on way of being better. Our operations allowed us to remain profitable despite a challenging environment. Unfortunately, unlike last year, market prices for fresh chicken as Lampkin will describe in detail, were mixed during the quarter.

Retail demand during much of the quarter was strong resulting in a higher Georgia dock than last year. While continued strong export demands supported leg quarter prices at levels ahead of a year ago, prices for white meat which includes boneless breast meat, wings, and chicken tenders lagged behind last years prices.

Market prices for both corn and soybean meal have remained high and volatile, and I expect that trend to continue through this fiscal year and into next year. The March planting intentions support indicated a move away from corn, to soybeans. In addition, recent planting progress reports indicate that the corn crop is not getting into the ground as fast as usual. This fact will contribute to even more volatility. The volatility in the grain markets does not surprise us, and I believe that conditions are such that there remains a significant risk of feed grains going even higher through the summer. Any weather event anywhere in the world this summer that threatens the yield or quality of this year’s grain crop could trigger a run-up in the price of grain, as could any event that results in even higher crude oil prices. With respect to soybean meal, the planting intentions and planting progress reports indicate a tight supply of soybean meal as well. Like corn, prices for soybeans have risen and we expect continued volatility in the soybean market. The bottom line is that our feed ingredient costs will be significantly higher in fiscal 2008 than during fiscal 2007.

We reported in February that we had not priced a significant portion of our grain needs. Since that time we have now priced much of our needs into the fourth fiscal quarter for soybean meal, and a portion of our corn needs. Based on what we have no priced to date, and assuming that we could price the rest of our needs through the end of the fiscal year at today’s prices, our feed ingredient costs based on 2008 volumes would be approximately $175- 180 million more this fiscal year than last year.

This higher cost translates to an increase per dressed pound of poultry of $7.6 per pound. Because our costs will be significantly higher, we need the chicken market to improve to allow us to offset the higher costs. Egg sets have moved down significantly over the last few weeks, and these lower egg sets should support higher chicken prices this summer. The question of course is whether this reduction in supply will move chicken prices enough to offset the higher grain prices.

I am pleased to report that our progress continues at our Waco facility which is now running at about 60% capacity. We expect to reach full production in Waco during October of this year. I am also pleased to report that we will have an office open in Kinston, NC on June 1st, and pre-construction activities are progressing on schedule. The additional production at Waco and Kinston will allow the company to continue its pattern of growth through 2011. At this point I will turn the call over to Lampkin for a more detailed discussion of the market and our operations during the first quarter.

Lampkin Butts

Thank you, Joe and good morning. As Joe mentioned, overall market prices for poultry were mixed during the quarter when compared to our second quarter last year. The average Georgia dock price during our second quarter was 6.1% higher than last years second quarter, averaging $.81 per pound during the quarter compared to a $76.4 per pound per average last year. The Georgia dock price this week is $.84 per pound, which compares to $.825 per pound for the same week last year.

Bulk leg quarter prices were higher for the quarter compared to last years second quarter, increasing 3.87%, reflecting strong export demand. Export volume to Russia was higher by 35.7% during the first calendar quarter of the year. Export volume to China was up 24.4%, and overall exports were up 18.3% compared to last year.

Bulk leg quarter prices averaged 42.9 cents per pound during our second quarter this year, versus 41.3 cents per pound during last years second quarter. Leg quarters are currently trading for $.46 per pound.

Prices for jumbo wings were weak during our second fiscal quarter when compared to last year. Jumbo wings averaged $.97 per pound down 15.4% from the average of $1.15 per pound during last years second quarter.

Boneless breast prices were also lower during our second quarter, decreasing by 10.1% when compared to the second quarter a year ago to an average of $1.45 per pound. This compares to an average of $1.62 per pound during last years second quarter. Today the market for boneless breasts is $1.52 per pound.

The overall result of these market price changes was the decrease in our average sales price per pound of poultry products sod of 1.5 cents per pound when compared to last years second quarter. This decrease represents a 2.2% decrease from last years second quarter.

While our sales price for poultry products decreased 1.5 center per pound, our price per pound of processed poultry increased 6.7 cents per pound. The companies cost for corn during the second quarter increased 28.3% when compared to our second quarter last year. Soybean meal costs increased 46.8% during the quarter. The average cost of feed in flocks sold increased 6.5 cents per pound, or 32.7% during the quarter compared to last years second quarter.

Our operating performance during the quarter was strong and our volume reflected the production at our new Waco facility. We sold 603.6 million pounds of poultry during the second quarter a 27% increase over the 475 million pounds during last years second fiscal quarter. We processed 594 million pounds of dressed poultry during the quarter, up 22.7% from the 484 million pounds we processed during last years second quarter.

Our pounds process increased 17% in our first quarter, 22.7% during our second quarter, and we expect increases during our third and fourth quarters compared to the same quarters last year of 17% and 13.5 % respectively. We now expect an increase of approximately 17.5% in pounds processed during fiscal 2008 compared to 2007. This increase will come as we continue to increase production at Waco and have a slight increase in overall bird weight.

While we previously reported that we expected to reach full production at Waco in August, weather delays in construction of poultry houses has pushed that date to October.

Performance improved at our prepared foods division during the second quarter, reflecting the lower cost of chicken meat, a principle raw ingredient at that plant.

Looking ahead we remain confident that we will continue to improve our operating performance and sales execution. We operated well during the quarter but will always be looking at ways to improve performance. We have also added significant new customers this spring. I am also looking forward to completing our new project in North Carolina which will position the company to pursue new markets and sales opportunities. At this point I will turn the call over to Mike Cockrell, our CFO.

Michael Cockrell

Thank you, Lampkin. Our financial results during the second fiscal quarter reflect the difficult market environment described by Joe and Lampkin during the quarter. Net sales for the quarter totaled $433.9 million, and that is up 20% from the $360.5 million during the same quarter last year. That increase was the result of the increase of poultry pounds sold f 27% offset by a 2.2% decrease in sales price, or a penny and a half per pound.

The $.30 earnings per share during the quarter compares to $1.33 per share earned during last years second quarter. Our cost of sales for the three months ended April 30, 2008 as compared to the same three months one year ago increased 34.7%. The increase is a result of the increase in pounds of poultry products sold in the second quarter compared to a year ago as well as the significantly higher feed costs. Feed costs in flocks sold increased 32.7% over last year, and feed costs accounted for 48.5% of our costs of poultry products sold during the quarter. By comparison, feed costs accounted for 42.37% of our costs of poultry products sold during last years second fiscal quarter.

SG & A for the second fiscal quarter of 08’ were up $1.1 million to $14.1 million when compared to $13 million in fiscal 2006. SG & A expenses during our third and fourth fiscal quarters will begin to reflect the administrative costs associated with construction of our new North Carolina facility. These costs will include training, salaries, and related expenses that will not be booked as costs-of-goods-sold until the plant begins operations in 2009.

Interest expense increased fro $1.3 million to $1.8 million during the quarter, reflecting higher outstanding debt and the capitalization of the interest related to the Waco plant during the second fiscal quarter of last year.

The company’s effective tax rate for the six months ended April 30th 2008 was 32.3%. This lower than expected tax rate is the result of higher than estimated Hurricane Katrina related tax credits, the estimated benefits of which were booked in 2007. The actual credits taken on the 2007 return were higher than we estimated by approximately $800,000 and we booked the benefit of that in this quarter. We expect our tax rate to be approximately 36% for the second half of 2008.

At the end of our second quarter our balance sheet reflected a stockholders equity of $413.8 million, and net working capital of $178.7 million. The current ratio was 2.8 to 1. Debt totaled $146.9 million and our debt-to-total capitalization ratio at the end of the quarter was 26.2%. We spend 28.2 million on capital expenditures during the first half of the year, and we also declared $5.8 million in dividends through the first half of the year.

While our net income and depreciation when added together exceeded our cash needs to fund capital expenditures, we still borrowed $50 million during the first six months of the fiscal year to fund working capital needs. Our inventories, which consist of live poultry, feed, eggs, and processed meat, increased $53 million so far this year. If grain costs continue to escalate so will our working capital needs.

During fiscal 2008 we now expect to spend $56.5 million on capital projects, and that includes approximately $17.3 million in vehicle and other leases. In addition we expect to spend $8.2 million on the new North Carolina processing complex during the fiscal year, and $118.3 million next year. That will bring that projects total cost to $126.5 million approximately.

Our depreciation and amortization during the first half of the year totaled $20.5 million and we continue to expect approximately $41 million in depreciation for fiscal 2008. On May 1st the company amended and restated its revolving credit agreement. The effect of the revolver amendment was among other things to increase our CapEx limits to allow for construction of the new North Carolina facility; to increase the available credit from $225 million to $300 million; to reset the minimum required net worth level and to extend the credit commitment to April 2013. In the amendment we also added four additional banks to the group, and the amendment reflected the removal of one bank from the facility. The revolver remains unsecured.

That completes our prepared remarks for this morning, and we will now open up the call to any questions that you may have.

Question-and-Answer Session

Our first question will be Farah Oslin, Stephens Incorporated.

Farah Oslin- Stephens, Inc.

Joe, could you share with us how the feed costs flowed through during the quarter? And how they relate to today’s costs in terms of did you have great hedges that you benefitted from in February, but kind of in April those ran our, and now you are pretty much experiencing the costs as they stand? Could you tell us how the costs of growing chickens today versus what they were during the months of the quarter?

Joe Sanderson

We had some beneficial feed cost advantages in the quarter, and our costs will be some higher in the next quarter, we believe, we will have some beneficial costs in this quarter versus the board, but they will be some higher in the third quarter versus the second quarter. But versus the board we believe that unless the board collapses there will be some beneficial versus the board. There will be some higher, but not significantly higher incoming ingredients in the third quarter versus the second quarter. We pretty much have the third quarter soy and corn priced. What we sell during the third quarter will have second quarter and third quarter incoming ingredients cost in it. So our live costs actually will reflect both of those ingredient prices, and the rate of increase should slow during the third quarter. The biggest increase in live cost should have already been seen and felt.

Michael Cockrell

As far as Lampkin said, the cost per dressed pound during our second quarter was up 6.5 cents. As he also said, if we priced all our needs out today that would reflect about a 7.5 cent increase. So we still have a little room to go to get to the full higher costs but most of it has been factored in.

Farah Oslin- Stephens, Inc.

That is very helpful. And when you look out to pricing for breast meat for the summer, can you give us some commentary for what you expect?

Joe Sanderson

I am cautiously not pessimistic. We expect based on egg sets, for supplies to be less and we would expect the market to improve beginning some time in June and for the market to be higher than it is today. Even with the consumer being under some stress from multiple sources we think that prices will be better.

Farah Oslin- Stephens, Inc.

My final question is, when you look to egg sets, when does the chicken industry start to build production for the July 4th holiday, and is that the reason we have seen the recent uptick in egg sets versus in a week-over-week basis?

Joe Sanderson

The excess that came out yesterday is past July 4th.

Lampkin Butts

If you add ten weeks to yesterday you are into the last week of July.

Joe Sanderson

Unless that was all fast food, that could be fast food chickens, 42 day old chickens for the fourth of July weekend.

Operator

The next question will be from Ken Zaslow, BMO Capital Markets.

Ken Zaslow- BMO Capital Markets

I have a couple of questions. One is can you talk about the difference between y our chill pack business and your big bird operation? Did one significantly outperform the other or are they relatively similar and profitable?

Joe Sanderson

We had good demand most of the quarter from the retail business. It might have lightened up a bit in April. Margin-wise probably the big bird deboning when you look at the quarter as a whole might have been better.

Ken Zaslow- BMO Capital Markets

In terms of your feed cost increases, I think last quarter you said that it was going to be about $174, and that now with corn prices and soybean meal prices going up you are only increasing it to $175-180. Is that respective because of the hedges that you have put in place, and you are buying aggressively, because it seems like last quarter you really weren’t that hedged, and now you are more hedged, but the price of feed only increased $1-5 million. Or did I make a mistake?

Joe Sanderson

No, we have priced our soybean meal needs through the fourth quarter at about88%. We are priced through the fourth quarter. If we priced the balance as of yesterday, and then we are priced probably 90% on corn for the third quarter; if we price the balance of the corn as of yesterday’s price we would be up $177 million for the year. That is where we are getting the figure.

Ken Zaslow- BMO Capital Markets

In terms of your operational efficiencies, I know you recently came out and said if you are a good operator you can get $.08-$.08, if you are a bad operator you lose that. What are you doing to actually improve your own operating efficiencies, not just from a big bird standpoint, but it sounds like in playing with the numbers a little bit, that Sanderson Farms, unto itself had better operating efficiencies and actually increased their underlying operations by a couple of pennies yourself. What are you doing differently?

Joe Sanderson

Every conference call every year, we say the same thing. Every year we review our operations and every facet within Agristats. Lampkin and his people do this; we set out operational goals every year; Lampkin and his managers and his group of 60-100, and they try to improve our operations within this benchmarking service we call Agristats. We try to improve. We always identify these goals and we try to get better. This year we have gotten better, and we are still chasing four or five good companies out there, and Lampkin and his people have done a good job of making up ground. It is a lot of things, and a lot of different places. Some of it is proprietary, Ken.

Ken Zaslow- BMO Capital Markets

The stuff that is not proprietary, can you give us some concrete examples? It is fascinating, to be honest with you, and it sounds like you just said that in the entire chicken industry you are in the top five according to Agristats in terms of operating…

Joe Sanderson

It was in our 10K last year. We placed fifth in Agristats last year. We paid fifth place in our bonus. All of our bonus is based in where we placed in Agristats among 24 companies we placed fifth place in our bonus.

Ken Zaslo- BMO Capital Markets

Can you give some non-proprietary concrete examples of what you are doing this year, and what you think you can do next year to improve?

Joe Sanderson

There are a hundred things we can do to improve. We are deficient in a hundred places. Our yields can improve, our feed conversion can improve, our sales can improve.

Mike Cockrell

We look at all those things every Monday morning Ken and we say ok, last week our hatchability versus the top 25% in the industry was either better or worse by so much, and right not it is pretty good. Our feed conversions are pretty good; our chickens are performing well; our processing costs in the plant versus the top 25% is good; our yield is really good. But there are some better than we are, and we still have room to get better.

Ken Zaslow- BMO Capital Markets

And you think the worst is past for you guys? It sounds like even in this margin structure. Is that fair?

Mike Cockrell

That is fair today, but it depends on where chicken prices are as Joe said in his prepared remarks. Chicken prices are not adequate right now to offset 7.5 cents per pound, and they need to move up.

Joe Sanderson

To get back to margins, this profit is not adequate. We are pleased we didn’t lose money, but this margin is inadequate for all the activity and assets and capital and everything this is inadequate. We need to make more money and chicken prices have to move up and there are still going to be a lot of people losing money at these market prices. The Georgia dock has to move up, breasts and wing and tender prices have to move up. We feel pretty good about the export market but basically white meat prices have to move up substantially from where they are today to move this industry, and I mean the industry, into a profitable area where you receive adequate returns. We are not there yet.

Operator

The next question will be from Michael Tygen, Cleveland Research.

Michael Tygen- Cleveland Research

A couple of questions: You mentioned that the industry margins aren’t where you would like them to be in the returns. Have you given any though to possibly slowing down production at any of your plants in order to restore a better supply and demand balance within the industry?

Michael Cockrell

No.

Michael Tygen- Cleveland Research

Do you think the cuts that the industry has made overall are sufficient to keep the industry profitable next fall, or if not what types of cuts do you think would be needed?

Joe Sanderson

We don’t know yet. We will make a cut as we always do after Labor Day. We will make a 4-5% cut following Labor Day as we always do going into Thanksgiving, Christmas, and January we reduce our egg sets and around Thanksgiving, Christmas, New Years and Martin Luther King. That is a period of slow demand for us, and we don’t announce that, but we always do it. It is just a period when we take down-days and we will do that. But if we think more is needed, we will evaluate that some time in August, and if need be will do it. We cut back in 2006, we cut back in 97-98’. I don’t know if we announced it or not, but we will do what we need to do. We don’t feel like we need to right now. We haven’t lost money, and we are ramping up a new plant, and don’t feel the need to at this point. If we feel the need to, we will.

Michael Cockrell

Michael, as you know , egg sets are just one part of the equation and Lampkin said export demand is brisk and good right now. Retail demand is pretty good, every day you read something about the food service industry suffering, and casual dining markets suffering. We have had to field a pretty good cut in production, but we will have to wait until we get into the summer and see if demand is sufficient or the combination of the two to move prices where they need to be.

Michael Tygen- Cleveland Research

What is your sense with Tyson shifting about 10% of their birds to big bird deboning over the near term? What do you see as the outlook for the big bird market over the next several months?

Michael Cockrell

We think that we compete against Tyson and have been for more than twenty five years and Traypak and fast food, they are good competitors and a good company and we will compete with the in big bird debone.

Michael Tygen- Cleveland Research

Finally, given that there is a lot of beef and pork out on the market, do you expect those increased red meat supplies to have an impact on chicken prices as we head in and are there things that the chicken industry can do to make itself more competitive given those strong supplies that are expected over the next several months?

Michael Cockrell

I think that in the short term that we have been surprised about the price on red meat, particularly pork,. Pork prices have moved up in the short term. We had anticipated cheaper pork, and we still think that might be coming, but in the longer term, when this $6 corn gets into pork and into beef, sometime later this year, and certainly into 2009, we think we are going to see much higher prices for pork and for beef, and we think we are going to be in a very advantageous position versus those competing proteins.

Our feed conversion advantage versus those two proteins ought to put us in very good shape long-term versus beef and pork. We are not really concerned about that too much. We think that consumers are going to eat some of all of it but long-term we ought to be in very good position versus beef and pork.

Operator

The next question is from Jeff Linroth, Living it Better.

Jeff Linroth- Living it Better

I need to briefly fix an oversight and say thank you Mike for helping me to get around at last years annual meeting and even more so thank the folks who were kind enough to take a little time out of their day to show me the operation and explain it to me.

A specific question I had about corn, obviously the two key drivers are the energy required to produce corn costs more, but also the fact that corn is being used to product gasoline which is I think has a chance to diminish when it becomes fully recognized that there are better ways to do that. The other question I have, for you Joe, is that you have discussed your limited availability to substitute away from corn, but what about other users of corn? What is your sense over the long term of other consumers of corn, and not just people who eat corn, but other business that utilize corn, their ability and possibly their willingness to substitute away from it. What is your sense on that?

Joe Sanderson

Certainly the cattle feeders, and we know that they can substitute it freely and easily, and if the ethanol producers can invest in the right processing and produce a product that cattle feeders can use readily. And to a certain extent the dairy producers can use it. We think that the more they produce, and if they produce more than the cattle feeders can use, if the chicken people need to use it, and they have to come to us, if they will invest in the processing and produce a consistent product that we can get through our mills, then we can use it too. But what we have sampled has been inconsistent. They have not had to invest in the capital in the processing plants thus far to make is readily useable for us. But when their market runs out, and they have to bring it to us, we believe they will do that.

Operator

The next question is from John Kohler, Oppenheimer.

John Kolher- Oppenheimer and Close, Inc.

I am concerned about the increased working capital requirements that the higher grain prices bring. I think you have the balance sheet to handle that, but I am wondering if you could possibly give some background on how the rest of the industry is handling it? I would think that the possibility for bankruptcy probably goes up from here, and I wanted to get your opinion on that.

Joe Sanderson

Frankly, when we did our modeling for our Kinston NC plant we factored in $7.5 corn along with a capital expenditure because we saw what it did right now wit $6 corn. That is how we came up with a $300 million revolver. It is going to take another leg up in corn, but should that happen you will increase the risk out there of some people being in trouble financially. I think there is a possibility of that happening.

Mike Cockrell

The big issue or concern that would put somebody in trouble is just access to the capital. If you have a one or two plant operator who may be a great operator, and some of those smaller guys are excellent operators, but they have to be able to access the working capital to fund this inventory. It is big, it is big for us and the two other public companies their inventories have skyrocketed as well. It is hitting everybody.

Joe Sanderson

The good operators are not going to get in trouble. It is going to be the 1-3 plant operators, and even a big operator that is not a good operator, they are the ones that will get in trouble. A poor operator is the one that will get in trouble; a leg up in corn stretched out on his balance sheet is the one that will get in trouble.

John Kolher- Oppenheimer and Close, Inc.

Do you see the working capital requirements actually reigning in?

Joe Sanderson

Absolutely, without a doubt.

It is always two things; it is never losses by themselves. It is always losses and bad balance sheets. It is never one by itself, it is two things that causes egg sets to go down.

John Kohler- Oppenheimer and Close

This is a follow up: have you given any consideration to acquisitions as opposed to new facilities?

Joe Sanderson

Our balance sheet is spoken for, but if an opportunity presents itself we would consider that.

Operator

Mr. Sanderson, there are no further questions. At this time I will turn the conference back to you for any closing remarks.

Joe Sanderson

Thank you for spending time with us this morning. We look forward to reporting our results to you throughout the year. Thank you.

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