Black Earth Farming's (OTC:BLERF) Richard Warburton on Q2 2014 Results - Earnings Call Transcript

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Black Earth Farming Ltd. (OTC:BLERF) Q2 2014 Earnings Conference Call August 15, 2014 3:00 AM ET


Richard Warburton - CEO

Erik Danemar - CFO


Sergej Kazatchenko - Pareto

Michael Schäfer - Equinet


Good day and welcome to the Black Earth Farming Q2 Report 2014 Web Cast Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Richard Warburton. Please go ahead.

Richard Warburton

Okay. Good morning everybody. Welcome to our Q2 report web cast. With me is Erik Danemar, our CFO; and Avto Makharoblishvili, our IR Director. We will be running through the numbers at the start. We have some key changes that we want to walk you through and point out in the way we have done the numbers, then we will talk through how harvest is going, how the markets are looking, and we will summarize and then we will take Q&A. So over to you Erik.

Erik Danemar

Thank you very much Richard, and thank you for joining us, as we present our second quarter and first half 2014 results. I will, as usual, start with a look at the income statement and then move over to the financial position, and also have a look at our cash flows.

So starting with the second quarter and first year income statement and profit and loss, and looking from the top at the revenues and gain, you will be aware probably that the revenue side in the first half of the year and the second quarter is selling off inventory, crop inventory from last year, i.e., from 2013, and the results on the gross profit line is really a mark-to-market crop revaluation that we do on the 31st of December, and the 31st of March.

Looking at the first half of this year, volumes were up significantly 43% year-on-year, but prices were significantly down, driving the overall revenue down in the first half of the year, 6%, that's also accounting for bad crop mix, FX. That said, prices were slightly higher over the period, compared to the valuations we did on the 31st of December, and again, on the 31st of March. So gross profit from realized sales were about $3.2 million in the first half of this year, versus a negative of $4.8 million last year, when prices were declining from the valuation points that we had at the end of the previous year, and the 31st of March and determined in the first half of the year.

Moving on to really the key item in the second quarter and first half results, revaluation of biological assets. In first half of this year, we had a negative revaluation of $0.5 million versus a positive $22.8 million uplift last year, and this is almost entirely due to a more cautious approach, when we look at revaluation of our biological assets.

Two key changes there in how we do things; one, IFRS guides us to use spot prices at the time of the date. We have moved, given the significant price changes that the market experiences, as the market moves from prior year crops, to this year's harvest crops. We have now reference that prices to this year's crops, and they are significantly lower.

In a similar fashion, we have also taken a more cautious approach to yield. So where we have less visibility in terms of already harvested results, we take more cautious yield estimates. But in our results here, you will also see that versus the current harvested results, the yields that we have used, in the biological assets, also are on the cautious side. In our published report, you will see details of revaluation but for the biological assets and the harvest results we have as of this date.

In terms of a like-for-like comparison, on the previous price approach, i.e., had we used spot prices on the 30th of June this year to value our biological assets this year, but using the same yields, evaluation would have been $23.5 million higher, so that gives you some sense of like-for-like versus last year.

Moving over to the cost side, remember, in terms of cost of goods sold, this is again the evaluation that we do of the inventory sold through the first half, first on the 31st of December of last year, and then again on 31st of March this year. So that's what goes in there, you will find that cost of goods sold are lower, and that's mostly driven by the revaluation effect, i.e., the uplift we had at the end of 2012 was much higher than the uplift we had in the end of 2013, and that was therefore carried into the cost of goods sold in the subsequent periods.

Cost of goods sold per tonne basis, if you exclude this revaluation effect, was also down 10% year-on-year, if you look at the first half of this year, but that includes also crop mix effects, which one needs to consider. Distribution costs, higher, that's driven by exports, but these exports covered these additional expenses as shown by the margin creation in the gross profit.

In other income this year, you will have amongst others, $7.2 million gross gain on sale of assets, so that's our Voronezh West and supporting assets, which we did a press release on. At the gross, you have about $1.9 million of tax expenses related to that, which sits at the table and were paid in cash after the end of the first half of this year. There is also a $1.3 million gain on our trading position in the first half, which has come up slightly after that, as prices came off further after the close of the period.

We announced here also, the sale of a smaller asset, Kalach, where we had 8,800 hectares of leased land, only we sold that for $3.4 million. Kalach was, as it were, our worst performing asset in 2013 across the whole group.

Noteworthy also to point out the reversal in FX position, that's the translation of the debt position we have in Swedish krona. If you recall the first quarter, we had a meaningful negative markdown of $8.2 million, $5.6 million of that was recovered, so to say in the second quarter, as the rouble strengthened. But we point out to the market, that from the end of the first half, the rouble has again slipped about 7.5%, so weakened against the U.S. dollar similar as to the Swedish krona.

So to summarize the P&L results, the key difference in this year versus last year is devaluation of biological assets, where we have taken this more cautious approach, but in our view probably, more [indiscernible] as well, and rational. If we would again make the price adjustment or use the price approach of last year, the like-for-like would be, on EBIT line, $18.1 million and net income $9.8 million to allow better comparison from year-to-year.

Moving over to the financial position and starting again from the top, looking at our PP&E, you will see movements from last year, from also the end of the previous year and through mid first half, at the end of the first quarter into this reporting period.

From the start of the year to the end of the first quarter, you will see a reduction due to the land and asset sales, there was the rouble effect there as well. That rouble effect reversed in the second quarter, the buildup in addition to that obviously had CapEx also going into PP&E.

After the sales, we now have controlled land of 271,000 hectares; 230,000 are owned and co-owned and valued on balance at $48.6 million. Buildings, mostly storage, valued at $54.7 million, machinery and equipment at $45.6 million.

Looking at current assets, and that's biological assets that we have spent some time on explaining how we approach that this year. It was valued at $72.5 million in the first half of this year. Remind you that there is a sort of completion factor in there as well. That was however, very similar year-on-year at 67%, which was again, very similar to last year. Last year that was $109.5 million, with coming to the differences in approach. In addition to that, last year's biological assets had crops from a bigger area, given the land sales that we completed in the first and second quarter of this year. In terms of inventories, materials for this year's crop and also the winter crops that we see for next year, $17.3 million at the end of the reporting period, $14.8 million last year.

Looking quickly at the cash flows; cash flow from operations were down $9.7 million, that's after a $10.5 million buildup in working capital and in terms of CapEx, we had $9.8 million. The gross proceeds from the land sales, both Voronezh West and Kalach were $23.5 million, remind you again, that's gross, so $1.9 million of tax following the [indiscernible] of this period paid on those sales. That cash went almost fully into buying back bonds. We bought back $7.8 million worth of bonds in the second quarter, and $9.3 million after the end of the reporting period.

At the end of the reporting period, at the cash position of $49.5 million in cash and equivalents, 70% of that approximately was held in foreign currency. In terms of debt, the total debt that is net of the debt position that we have bought back, $86.6 million, net debt, $37.1 million, and total debt to total equity and covenant of 41% at the end of the first half of this year.

And with this, I give the word to Rich.

Richard Warburton

Thank you. Moving to operational matters; we are well into harvest now, taking advantage of the hot and dry weather, which we just finished at just over 4 tonnes, that's up 22% on last year. Barley and spring wheat are not finished yet, but looking like they will be significantly up from last year, currently some 39% and 98% up on yield, at 3.6 tonnes and 3.7 tonnes a hectare.

Peas and rape (spring rape), we are really just getting started there, but initial yields again look favorable at 3.4 tonnes, 1.4 tonnes respectively. That's 56% and 99% up on last year. Obviously a good growing season and spring got going earlier, so we have had a longer season, and I think more significantly, it has been cooler than normal and brighter in the early part of the season.

It's pleasing that we are seeing much bigger uplifts within our own business compared to the annual -- the average regional uplifts that we are seeing survey data for. And by the way, they vary quite a lot across regions.

Quality-wise, we have on the wheat, less plus three wheat, mostly due to proteins running lower this year. Normally we have a lot of 14% plus protein wheat. That's not the case this year, but we have a lot of plus 4% wheat which we get premiums on. The splits on quality without wheat is 15% plus three, between 50% and 60% plus four, the balance seed, plus five.

Malting value works the other way, the lower proteins help us here, and we are expecting more barley to be malting quality than normal. Some way to go yet, but we expect the malting quality range to be 55% to 65% or so.

Looking forward, we have lower expectations for our soya crop. This has been most affected by the dry weather. It has not been vigorous and if soils are dry, pretty much those herbicides don't work well without moisture. So we played an expensive game of catch-up on weed control with this crop.

Sunflower and corn, we feel we have done a good job on, we have gotten them planted much earlier than previous years. They went to flowering, which is a very critical phase for corn in good, cool conditions without drought stress. But it has been dry for nearly a month now. So I think we'd like some more rain to make sure we get the full potential from those crops.

It has also been very hot this last month, and that's not good for potato. Potatoes shift down on bulking, if the temperature is above 30 degrees, and all water in the world won't change that. So this hot weather has not been great for our potato crop. That said, our early yields and quality, we started harvesting -- the harvesting program in July and delivering it to the factory looks quite favorable.

On the markets, as many of you will know, we are looking at second very large global harvest. Maybe just a percentage point or two off last year's record in harvest, and this obviously has implications for prices. In Russia, similarly, a big harvest expected, total grains expected to be up more than 10%, wheat expected to be up about 15%. So predictions on total grains, $98 million, $99 million compared with $89 million and $71 million for the two prior year's respectively. So a big multiple surplus. Quite significant quality issues and wide differences in prices for, particularly wheat, between feed and milling wheat.

By our estimates, if you compare harvest year versus harvest year without any prior year figures in there, we think average, we are about 15% down on price. Corn, sunflower and oilseed rate, they are all more than 30% below five year averages. So these are pretty low prices, and those prices vary significantly off 10-year trends now.

In terms of our marketing, we have us posed in more reliant on futures this year than usual. We are roughly, in terms of our positions, we are roughly half physical forward sales, half hedged on futures. In terms of physical forward sales, we have our usual contracted positions on potatoes, [indiscernible] sunflowers, with PepsiCo and barley contracts with maltsters, plus we have also got some rape, winter wheat and soya sales.

With regards to the futures, we have -- its mostly winter and corn, and we have sales of wheat futures on Chicago and MATIF, and we have sales of corn futures on course on Chicago.

In terms of the value of those positions, we reckon combining both physical forward sales and the futures positions, versus the current spot market. We reckon that we are something like $11 million, $12 million as we speak.

Export program has started, railcars have been turning up and leaving our business. Slightly slower start this year, as we are in general, selling slower this year to avoid what we perceive could be a low and lengthy depressed harvest end market.

In terms of what compared to the [ph] full year, well it’s the usual suspects. Price obviously, we have very high price volatility in this part of the world, plus or minus 40% and $10 price change across our basket of crops is nearly $9 million, in terms -- as a sensitivity. Similarly, we have high yield volatility and 0.1 tonnes a hectare is somewhere between $4 million and $5 million. Clearly corn is a crop that will likely have the most impact on our full year.

As ever, we have to get crops in the store, so we need to do this cheaply and we need to maximize quality, especially this year, given the spreads between feed and quality to important building projects. In that regard, we have four new dryers that we are installing, because we have so much more corn in the business. So that is on track, and we will be ready for that corn harvest.

Similarly we are building storage facilities for this season's potato crop, and again oil plant needs to be ready for September.

So to summarize, a lower result versus last year, this is entirely down to a different approach. On a like-for-like basis, it would be a much better result. We have gone to considerable length to make that change as clear as possible. So we hope that comes through in the report. A strong start on harvest, with yields significantly upon last year, but we have a long way to go. Most of our revenue is still standing out in the fields.

Spot prices now pretty low, down some 15% on last year. At this stage, costs are under control. We continue to work hard, developing out and expanding our [indiscernible] price for next year, and starting to look beyond there as well.

The Kalach divestment was very important. This was a poorly performing farm. So good to have got that sold. We continue high levels of activity on -- divestments and acquisitions.

As Erik pointed out since the quarter end, the rouble has weakened somewhat, given the geopolitical situation, which is a complicated and challenging picture. You would all be aware of the import bans. It looks now likely not to be accompanied by an export ban, which was saw as the biggest downside risk; and if you just consider, in terms of the import ban and not the wider picture, potentially some positives in the medium term.

There has also been a bill submitted to the Duma which is, at sort of very early stage, but it appears anti-foreign ownership and anti-large scale farmers. It’s the first of what would need to be four stages for it to come into law. It's very difficult to understand the motivation behind this bill. We don't think it’s a retaliatory move, because of the data which submitted. We have looked into this. It's impossible to clarify the impacts on our business at this stage, even if it did make into law. So we are monitoring that situation.

Despite that backdrop, a pleasing stuff to harvest, in terms of productivity. Obviously a good growing season in Russia, but in large part. It reflects the many initiatives improvements taking place in the business.

I think at that stage, we should hand over for Q&A.

Question-and-Answer Session


(Operator Instructions). Our first question today comes from Sergej Kazatchenko from Pareto. Please go ahead.

Sergej Kazatchenko - Pareto

Hello and congratulations to great yields. As a start -- couple of questions if I may; first of all, if Erik, maybe can repeat the numbers regarding the like-for-like changes both on if you would do the same -- similar reports as you did last Q2, the effect on EBIT and an effect on net profit?

Erik Danemar

Sure Sergej. What we have shown is that like-for-like if we had used the same approach on prices. So we have not calculated the -- for the market, the effect of yields. But starting with the price effect; again, so to be clear, what we would do then. If we would do the prices as of the 30th of June this year, rather than more current spot prices that we have applied, the difference in valuation over biological assets would be $23.5 million, and that is an uplift, that would flow through the whole income statement. So the EBIT for the first half of the year would go up to $18.1 million and the net income to $9.8 million, again in the first half of the year.

For the yields, there again, we have taken a more cautious approach. Well I think -- I would refer the market to do there is, to look in our published report, where we give the yields that we have applied in the biological asset valuation, that's on page eight in the report. If you compare that to page nine, where we have the current harvest progress, you will see that we are on the cautious side there as well.

We do have harvesting left to do on some of these crops, so there is reason not to -- use the current yields that were taken off the field. But we would probably feel, that again, we are on the cautious side there as well.

To this effect, we haven't quantified for the markets [indiscernible]. We have just looked at the price effect there.

Sergej Kazatchenko - Pareto

And regarding the -- you say 10% like-for-like effect on costs, but if you'd assume the mix changes, what would be like-for-like and adjustment for the mix, second half?

Erik Danemar

That's quite a complex calculation, because you then need to look on a per crop basis. What I can say, I mean is that for corn, which was the biggest crop sold in the first half of the year, we had a decline which was similar to what we discovered, so that captured on top of the mix effect.

Sergej Kazatchenko - Pareto

Was about 10% of that as well?

Erik Danemar

Correct, yes.

Sergej Kazatchenko - Pareto

Okay, great. And then maybe a couple of questions on operations; one important factor that I would like to understand is, I mean, the yields improvement is great, but is there any way to kind of -- for you to see whether that's a weather effect, or how much of that is actually underlying improvement if you have achieved?

Richard Warburton

Yes. Good question Sergej, and obviously very key. The only we can do that at this time of the year, is to look at survey data for yields within our regions, and if you look that data and just make one cautious note, that's what we are looking at our bunk-away, so this is growth data versus the figures we have given you, which is net data.

If you look at the figures for our regions for wheat, if you look at the uplifts on 2013, you see a very mix picture from no lift at all in Tambov through to the most pronounced uplift, which is in Voronezh, nearly 30%, and much more modest uplifts in Kursk and Lipetsk, this is on the survey data. On average for wheat, those uplifts are somewhere between 10% and 15%, and our lift is 22%.

If you look at barley, barleys have bigger uplift generally, but again the range between our regions is from 9%, again this is the survey data, the [indiscernible] survey data. Its 9% in Tambov, reached 29% in Voronezh and Kursk and Lipetsk again in the middle. The average being 15% to 20%, and we have got some uplift at the moment of 38%, 39%. So it's pleasing that we are coming ahead of the regional average uplifts.

Sergej Kazatchenko - Pareto

Excellent. And one factor for us to understand is the forward sales that you have done already. I mean, the price is down quite a bit, can you highlight the volumes of the physical forwards that you have already agreed upon, and in terms of may be some indication on the prices of that.

Richard Warburton

I can give you the percentage of revenue that's of physical forward sale, it's about 27% versus 26% that's hedged. In terms of the volumes, most of our volumes sold -- all our potatoes are sold substantial amount of soya, rape, little bit of some flowers, oil peas, a little bit of corn is sold, a little bit of wheat. Does that help, Sergej?

Sergej Kazatchenko - Pareto

Yes. Absolutely.

Richard Warburton

Then if you come -- on the futures position, we have explained those that's mostly about wheat and corn, and I think we give the percentage of crop tonnage is covered, and I think we have estimated the value of those positions versus swap between the total of physical and futures positions versus swap between $11 million and $12 million.

Sergej Kazatchenko - Pareto

And just a reminder, you do book the value every quarter, at the end of the reporting date, at the real -- the gains is basically market pricing every quarter, at the end of the quarter, right?

Erik Danemar

The future positions for the trading book is booked at market. So if you have an increase in value of our trading position, that goes through P&L. So for example again, the first half of the year was plus $1.3 million. The forward prices do not get mark-to-market, when we value biological assets. When the harvesting field, it goes from the field into storage, and becomes inventory. We are using contract prices to valuate. But, given that we don't have any proper storage at the end of -- for the first half, that's based on the current market's estimated price that we see in the market, rather than the 30th of June.

Sergej Kazatchenko - Pareto

Okay. Excellent. And then maybe last question on the cost side; you have been looking on your cost side, and if you just look at underlying costs, overall on or excluding the mix effect. So what's your best guesstimate in terms of the like-for-like cost year-over-year last season versus the season that is coming, on a general basis?

Erik Danemar

I think, you know Sergej -- our main focus on the cost per tonne basis, and that -- given that we are taking that sort of cautious approach on -- let's say about yields, we need to do so on the cost side as well. I think here, and at this point of the year, as Richard said, we are in control of costs, which means that there is some cost inflation basically into some of the inputs we have. But we think we are on top of that, and within or on-budget plans. If we can maintain the sort of positive trends on the yields that we are seeing at this point, then we should have a contraction on per tonne costs. But again, there is a lot left in the year to see, where we end up on that, but its looking constructive and positive at this time.

Sergej Kazatchenko - Pareto

Thank you.


(Operator Instructions). Our next question comes from Michael Schäfer from Equinet Bank. Please go ahead.

Michael Schäfer - Equinet

Yeah. Thanks for taking my question. Its probably a question to Richard. Its on -- in your six month statement, you were referring to negotiation with the Russian State Bank and looking for a new credit facility. So I wonder whether you can provide us some more color too -- or how this is going these days, given the geopolitical risks we have seen? Maybe also an indication on the overall magnitude, and whether or not you're essentially relying on this, given that you have $50 million of net cash shortly ahead of harvest days and then cash in. So just to get a better picture on your financing side or your working capital needs in the next couple of months?

Richard Warburton

So we are not relying on it, and we do refer to that in the report. But Erik has been leading on the negotiations, so I will let him fill in the details, if I may?

Erik Danemar

Yeah thank you, Richard, and thanks for the question. We have made great progress with a leading Russian state bank on a credit facility. There has been a hold up in the process, whether that's related to the political situation or not, and the sanctions that have been imposed on Russian banks on funding themselves in Europe, long term. Hard to say, they may have taken a more cautious approach or at least temporarily. So we are continuing to work with them, both on working capital in terms of credit, and also looking at some investments, longer term funding. But the answer to the question is, again, there has been -- we were hoping to have more complete progress in the third quarter now, and I feel that can move into the fourth quarter even. Otherwise, that is attractive funding still.

In general, the banking rates have followed the sovereign rates, so if you look at the spreads to U.S. treasuries, they are up about 150 basis points I think from the beginning of the year, and the banking rates indicated to us, have followed that lead, so they are also up. But remind you, that these are subsidized rates, so the net interest that we would pay on such a facility are still quite attractive to us.

So we continue to pursue it, but it has moved slightly into the future, and that may be related to the political developments. But again, we continue work on several levels there, so we are still quite optimistic that we will achieve such net credit.

Michael Schäfer - Equinet

Am I right saying that you -- since you are not relying on it, so there won't be any negative effect for the preparation maybe right after the harvest for the next season?

Erik Danemar

No. There won't be any negative effect. I mean, clearly, I would like to replace some of our bond funding with subsidized Russian rouble funding, it also reduces the currency risk, and it matches our working capital slightly better. But no, in terms of our current work, we don't expect it to impact, no.

Michael Schäfer - Equinet

Maybe a follow-up on your bond buyback; so could you update us, where are you now and are there -- what are the plans then for the next six months?

Erik Danemar

I would say probably that -- only that. We use the proceeds from the asset sales that we did, almost on a sort of matching basis, one-to-one two [ph] and buyback bonds. As Richard has mentioned, we are actively considering both divestments and acquisitions to continue to optimize our land portfolio. If there is a close match between selling and buying, then we would probably have kept the cash to bridge that. But we don't have any clear visibility on that in the near term. So that's why, that money was used to make our capital structure more efficient instead, and with that, as sort of a base point for you, I think we are -- we will sort of move forward also, and see where we are on that decision before we make further decision on what we do in the bond market.

Michael Schäfer - Equinet

What the current position is?

Erik Danemar

Sorry is it the current bond position? Well $35 million as we hold on that at this time.

Michael Schäfer - Equinet

Okay. Thank you very much.


There are no further questions.

Richard Warburton

Okay. So thank you very much everybody for dialing in. Thank you particularly for the excellent questions. On that note, we will close our web cast. Thank you.


That will conclude today's conference call. Thank you for your participation ladies and gentlemen. You may now disconnect.

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