Adecoagro SA (AGRO) 2016 Q2 法說會逐字稿

Good morning, ladies and gentlemen and thank you for waiting. At this time, we would like to welcome everyone to Adecoagro's Second Quarter 2016 Results Conference Call. Today with us we have Mr. Mariano Bosch, CEO; Mr. Charlie Boero Hughes, CFO; and Mr. Hernan Walker, Investor Relations Manager. We would like to inform you that this event is being recorded and all participants will be in listen-only mode during the Company's presentation. After the Company's remarks are completed, there will be a question-and-answer section. At that time, further instructions will be given.

(Operator Instructions) Before proceeding, let me mention that forward-looking statements are based on the beliefs and assumptions of Adecoagro's management and on information currently available to the Company. They involve risks, uncertainties and assumptions because they relate to future events and therefore, depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of Adecoagro and could cause results to differ materially from those expressed in such forward-looking statements.

Now, I'll turn the conference over to Mr. Mariano Bosch, CEO. Mr. Bosch, you may begin your conference.

Good morning and thank you for joining Adecoagro's 2016 second quarter results conference. As you might have seen in our release, we reported strong results in all of our businesses which was a combination of a number of factors of which our daily work and effort to maintain a low cost of production constitutes the most important one. As we have always remarked, being the low-cost producer is the only way to run a profitable business in an industry where we cannot control variables such as price and weather. Basically, our formula to control and reduce costs consist of one, enhancing both industrial and agricultural efficiencies and two, increasing productivity. In our earnings release, we have shown productivity increases in all of our businesses. For example, in Argentina, we are reporting crop yields in line with the previous season which was record harvest despite the abundant rainfall that we suffered. Our milking cows continued increasing productivity reaching more than 35 liters per day per cow, the highest in the industry. In our sugar, ethanol and energy business, TRS per hectare increased quarter over quarter reaching 13.3 tons per hectare.

This industrial and agricultural enhancement dilutes our fixed costs and are reflected in the results of each quarter. Specifically in the sugar, ethanol and energy business, we have reported that our industrial and agricultural cost measured per ton of sugarcane crushed and per ton of TRS have decreased by 12% and 9% respectively. We are aware that there are still many things that can be improved and fine-tuned to continue reducing our cost of production. We are very optimistic and excited about our prospects.

We are very proud on the quality of the operational and management teams which we have developed in each business and are confident that we will reach our operational and return targets. At the same time, we continue looking for accretive growth opportunities in each of our businesses lines to continue generating value and attractive returns for all of our shareholders.

Now, I will let Charlie walk you through the numbers of the quarter.

Thank you, Mariano. Good morning everyone. Let's start on page 4 where I would like to comment on the weather conditions in our cluster in Mato Gross do Sul. As you may see on the chart, the recent excess rainfall in May which caused logistic and operational disruptions. As we have explained in the past when the soil is humid we have to stop harvesting activities to avoid damaging the soil with the heavy harvesters, tractors and trucks. Rains in May and the first half of June were not only above the historical average but also highly dispersed resulting in significant operational downtime.

Let's move to page 5. As a result of the excess rains, we had 13% less effective milling time in the quarter. At the same time our milling volume to-date increased by 6% as a result of the ramp-up of the Ivinhema mill and higher operational efficiencies across harvesting, logistics and milling operations. As a result of these two factors, we were able to crush a total of 2.7 million tons in the second quarter of 2016, 8% below last year. On a year-to-date basis, however, due to the early commencement of the harvest as part of the continuous harvest model that we have implemented since the beginning of the year, sugar cane crushing has increased by 24% year over year. Finally, I would also like to highlight that in July and first week of August, rains have normalized and returned to historical average. Therefore, we have been able to accelerate the pace of milling and have compensated most of the delay generated in the second quarter.

Please turn to page 6 where I would like to highlight a few agricultural productivity metrics. We remain fully focused on agricultural productivity since we understand that it's the main driver for becoming a low-cost producer. Over 70% of total production costs are related to sugarcane production of the fields. As a result, yields per hectare during the quarter have reached 111 tons, 11% higher than last year while TRS per ton has decreased by 7% as a result of the excess rains. Finally, TRS per hectare remained 3% higher than last year.

Let's move to slide 7. Production during the second quarter has been negatively impacted by the decrease in sugarcane crushing. As a result, sugar and ethanol production fell by 10% and 12% respectively, resulting in an 11% decrease year in TRS equivalent produced. Energy exports only dropped by 6% since we've begun burning our stockpile of bagasse carried since the first quarter as market prices began increasing. As explained earlier, this is the only delay in production which we expect to offset during the third quarter.

Let's now move to slide 8. Despite lower milling and production volumes, we have been able to reduce our operational costs. As you may see in the table, unitary production costs measured in terms of sugarcane crushed and in terms of TRS produced, decreased by 12.4% and 8.8% respectively in the second quarter. Furthermore, cost dilution was achieved at both the industrial and agricultural sides of the business. This has been the result of an ongoing process of efficiency enhancement and fine-tuning across the entire production process seeking to become the low-cost producer of sugar and ethanol in Brazil. The depreciation of the Brazilian real also contributed to the dollar cost dilution given that most of our cost of production are measured in local currency. On a year-to-date basis, unitary production costs have also decreased by 20.4% and 15.4% respectively.

Now let's please turn to slide 9 where I would like to discuss sales. Net sales during the quarter were $86.3 million slightly higher year over year. The dynamics of sales are mainly driven by present unexpected relative prices. During the second quarter of 2016, sugar prices were much higher than ethanol prices measured at sugar currently. This explains why production was more skewed towards sugar production during the quarter and sales volume increased by 20% compared to the same period of last year. In the case of ethanol, sales volumes decreased by 22% compared to last year, resulting in an 18% decrease in sales. This is explained by our ethanol carry strategy due to market seasonality.

Ethanol prices are highly seasonal. Prices are usually very weak during harvest time as all millers are crushing and supplying ethanol to the market. As we get close to the end of the harvest, ethanol volumes start to decrease pushing prices up. Prices with seasonally high during the first quarter for mills stopped milling generating a shortage of supply. We are able to benefit from the seasonality curve as a result of our current capacity and our strong balance sheet. During the end of second quarter, we decided to minimize ethanol sales and start to fill up our tanks in order to capture higher prices towards the end of the year and enhance our margins.

In the case of energy, despite a 19% increase in volumes sold, sales were 47% lower than last year. This is explained by lower cogen prices as a result of normalized hydropower supply and lower energy demand.

Finally, to conclude with the sugar, ethanol and energy business, I would like to focus on slide 10. Here, we can see the overall financial performance of the sugar and ethanol and energy business. Adjusted EBITDA in the second quarter of 2016 reached $50.6 million, 3% higher than the second quarter of 2015. Adjusted EBITDA margin grew from 57% in the second quarter of 2015 to 59% in the current quarter. Despite an 8% reduction in sugarcane crushing due to excess rains, lower ethanol sales as a result of the implementation of an ethanol carry strategy to capture higher prices towards the end of the season and a $13.1 million mark-to-market loss from our sugar hedge position, we were able to increase margins. The main factors contributing to enhanced financial performance during the quarter were, a 12% reduction in unitary production costs as a result of our focus on operational efficiencies and the devaluation of the Brazilian real and higher sugar prices and sugarcane yields resulted in a $17.7 million increase in changes in fair value of unharvested sugarcane offsetting the negative mark-to-market result of our sugar hedge position.

On a cumulative basis, adjusted EBITDA for the first six months of 2016, grew by 41% reaching $72.7 million. Adjusted EBITDA margin expanded to 47%. These results are primarily explained by a 24% increase in crushing volumes coupled with a 17% increase in TRS sold. As a result of the early start of the harvest due to the implementation of the continuous harvest model, enhanced agricultural efficiencies and real devaluation resulting in a 20% dilution of unitary production costs and higher sugar prices and yields resulted in a $27.7 million year-over-year gain from the fair value of unharvested sugar. Results were partially offset by a $12.3 million loss generated by the mark-to-market of our sugar hedge position compared to a $13.9 million gain generated in the first six months of 2015.

We will now turn to slide 12 of the presentation where I would like to give an update on harvest of our most relevant crops. As you can see in the top left chart as of July 2016 the harvest of soybean first crop was fully completed. Average yields achieved were overall 11% lower than previous harvest season. Productivity was highly variable by country and by region as a result of weather volatility caused by El Nino.

So I would like to analyze performance by countries. In Argentina, the northern region was affected by excess rains during May. Yields in that region decreased by 13.5% compared to last year, reaching 2.4 tons per hectare. In the Humid Pampas, the timing and intensity of rainfalls were optimum allowing the crop to fully develop. As a result, yields reached 3.6 tons per hectare, in line with the previous harvest season, which has been record crop. Overall, yields in Argentina decreased by 5.9% to 3.2 tons per hectare, but remained above the historical average.

In the case of Uruguay, the region was affected by the strong El Nino, which took place during first half of the year. This resulted in excess rainfalls and floods, which negatively affected yields and quality of the crops. Yields were 25% below the previous season. In western Bahia, Brazil, contrary to what happened in Argentina and in Uruguay, El Nino resulted in a severe drought. As a result, yields were 20% below year over year.

The harvest of soybean second crop was also completed. Average yields reached 2.4 tons per hectare in line with pervious harvest year, which were also a record crop. High productivity was driven by executing an efficient planting schedule.

In the case of corn crop, as of the end of July, 54% of the total planted area was harvested. The average yields obtained so far were 6.2 tons per hectare in line with the previous season. As you may see in the pie chart, in order to diversify our crop risk and water requirement, approximately 24% of the corn was planted early in September, whereas the remaining 76% was planted during November and December. The harvest is expected to be completed during August and we expect corn yields to remain in line with current levels.

Lastly, in the bottom right graph, we can assure that as of the end of July the harvest of sunflower was completed producing over [15.5000 tons]. The average yield was 1.6 tons per hectare, slightly below the previous harvest year.

Let's move to page 13 where I would like to walk you through the financial performance of our farming business. As you may see in the chart, on a quarterly basis, adjusted EBIT for the farming business was $5.1 million, 85% higher year over year. This increase is mainly explained by the crops business. Adjusted EBITDA for crops reached $3.4 million growing 389% higher year over year. This increase is mainly explained by the crops business. Adjusted EBITDA for crops reached $3.4 million, growing 389% year over year. The increase is primarily explained by a $23.1 million increase in crops margins resulting from higher corn and soy prices in the local market as a result of the elimination of export taxes and quota, lower production cost as a result of the depreciation of the Argentine peso in real terms coupled with lower input prices of seeds, fertilizers and agrochemicals. Results were partially offset by a $20.1 million loss derived from the negative mark-to-market of our commodity hedge position.

Regarding the rice business, due to a seasonality and growth cycle of the rice crop, most of the margin generated in the 2015 to 2016 harvest was recognized in the first quarter of 2016 when the crop was harvested. Adjusted EBITDA generation during the rest of the year is driven by sales of processed rice and by products, net of selling expenses and overhead costs. Adjusted EBITDA grew 408% compared to last year, driven by higher sales volumes.

In the case of dairy business, our operational performance during the quarter was very good and we continue to see improvement in productivity as we consolidate the free stall facility. Milk production volumes reached 21.6 million liters, marking a 3% increase year over year driven by a 2.6% increase in our dairy cow herd. The gains from productivity were offset by lower selling prices resulting in a 39% decrease in adjusted EBIT.

On page 15, I would like to comment on commodity hedging. First of all, as a reminder, I would like to make a few comments regarding the rationale and strategy of our hedging program. First, Adecoagro (inaudible) commodities, since we own the productive assets, both land and industrial facilities. Secondly, our margins and cash flows are affected by a the volatile price environment inherent to agricultural commodities. The objective of our hedging strategy is to mitigate short-term price volatility allowing to lock in margins and securing a more predictable and stable cash flow to face capital obligation and working capital requirements of the upcoming 6 to 12 months.

As you may see on the chart on the left, we have entered into hedge position for our soybean, corn and sugar production related to the current harvest and have also started hedging next year's production. As a result of the commodity driving experienced during the second quarter as you may see on the top chart, the mark-to-market of our hedging position as of June 30, 2016 resulted in $34.1 million loss, which is mostly unrealized.

However since June 30, commodity prices have decreased reversing most of the loss booked in the quarter. In addition, I would like to highlight that biological assets and grain inventory in our income statement are also measured at fair value. Therefore gains or losses from our hedge position are naturally offset by change in the fair value of biological asset and the mark-to-market of the inventory. In the case current crop hedged, the offset is immediately recognized in the quarter. While in the case of next year hedge positions, the offset is delayed until the crop is planted and harvested.

Let's now turn to page 16 which shows the evolution of our Adecoagro's consolidated operational and financial performance. On a consolidated basis, net sales decreased year over year mainly explained by lower production volumes and the implementation of an aggressive ethanol carry strategy, partially offset by higher sugar and ethanol prices in dollars.

Adjusted EBITDA in the second quarter of 2016 totaled $51.1 million, representing a 7.6% increase compared to the second quarter of 2015. Improvement in financial performance was primarily driven by higher soybean and corn prices in Argentina and dilution of production costs as a result of the depreciation of both the Argentine peso and the Brazilian real combined with enhanced efficiencies in our operations. On a year-to-date basis, adjusted EBITDA stands at $94.4 million, 39% higher than last year. We expect Adecoagro's production volumes and financial performance to continue growing in line with historical growth, mainly driven by the consolidation of our sugarcane cluster and an increase in the operational and financial efficiencies in each of our businesses.

Let's now turn to slide 17 to take a look at our net debt position. As you may see on the top left chart our gross indebtedness as of June 30 of 2016 stands at $791 million, our net debt stands at $623 million, essentially unchanged compared to the same period of last year. However, we expect net debt to fall during the third and fourth quarter as we start generating positive free cash flow. I'd like to highlight that 62% of our debt is in the long term composed mainly of loans from multilateral banks such as BNDS at very competitive rates.

To conclude, let's move to slide 18 to discuss our capital expenditures. Year-to-date capital expenditures decreased by 35%, reaching $63 million as anticipated. This reduction is explained by the completion of the Ivinhema mill. We're currently expecting full year CapEx to reach approximately $110 million of which approximately $70 million correspond to maintenance CapEx and $40 million to expansion CapEx. Expansion CapEx is primarily related to the continuous harvest model in the sugar and ethanol business. As explained in the first quarter of 2016 earnings call, this new production model will allow us to crush approximately 1 million ton of sugarcane per year, increasing nominal capacity from 10.2 million tons to 11.2 million tons.

Although there is no investment CapEx required, we must invest in expanding our sugarcane area to be able to supply the growing capacity. In addition, expansion CapEx also includes launching an investment in our rice and dairy operations to expand capacity and improve operational efficiencies. These investments have very high marginal returns. Despite increasing our CapEx focus for the year, we continue expecting to generate free cash flow net of changes in volumes in the range of $80 million to $90 million.

Thank you very much for your time. We are now open to questions.

Thank you. The floor is now open for questions. (Operator Instructions) Thiago Duarte, BTG.

I have two questions, one is related to this CapEx, projected CapEx that you mentioned in your last slide and the comment that you made on the free cash flow. So just on the CapEx is basically whether we should see -- okay I understand in 2016 we should see the CapEx a little bit higher than what we were previously expecting on the back of this $40 million expansion CapEx. So just wondering going forward, if we expect to have any incremental expansion CapEx at this point or if we should consider the $70 million as a good proxy of what should see in terms of recurring CapEx in the coming years?

And regarding the free cash flow, just to understand, you previously had -- my understanding is that you previously had this expectations of any $80 million to $90 million of free cash flow this year before we had this higher CapEx. So just wondering why you think you're going to be able to meet this goal of $80 million to $90 million free cash flow now with $40 million more CapEx. So just wondering what else you're seeing down the road so that you're going to be able to offset the higher CapEx and keep that free cash flow guidance?

Hi, Thiago. This is Mariano. On your first question, on your question on what should we expect going forward to 2017 that regarding CapEx of $70 million, I think it sounds reasonable and it's something that we could potentially expect.

Regarding whether we would see some additional expansion CapEx or not, as we always mentioned, we are going to be very disciplined on the return on investment that we could see there. So if we have very attractive projects like what we presented this year like this expansion of 1 million tons more with a very small investment of less than $30 million or this additional investment that we are taking in rice that because of all the changes that happened in Argentina and we are, for example, transforming a pump station in a rice field that we are transforming the pump station from diesel to electricity. The payoff of this project is a year and a half, so returns are above 50%. So as we continue to find these additional marginal projects with very high returns, we can see some additional investments, but only in that case and continue with our focus of being always the low cost producer on each of the commodities that we are producing. So that's the answer to your first question.

Then, on the second question, on whether these projected free cash flow of $80 million to $90 million, why is it that we continue to project that is because we are projecting our results and we are projecting our carry strategies et cetera, et cetera that we continue to see this number in the free cash flow generation.

Okay. That's good. Mariano, thank you very much. And if you could have a follow-up question, just to get your view a little bit. It's been more than six months since you had the reduction in the export taxes in Argentina. My understanding is that the business environment in your sector has improved substantially since that happened. The currency has depreciated as well. So just from the -- looking specifically into the land transformation business, you guys have consistently sold farms in the past, even when the business environment was not as compelling. So just wondering whether you're seeing a good prospect in terms of more land monetization and land transformation, land prices improving or anything like that. Just seeing, I mean, in the real world whether this change in the taxation and there is better business environment is really impacting your business in the form of seeing more bids for land, higher land prices something that we could expect to see even more and even better prices going forward? Thank you.

Okay, Thiago, good question. Basically the returns of the land that we own have improved, because of this improvement on the business environment allover Argentina. So we do expect prices of land to grow in line with what has happened on its profitability. So in general, we would say that we would expect higher prices of land for Argentina. In terms of our land transformation business, I would say that we will continue to monetize in line with what we've been doing in the past and that's something that we've been doing for 10 years. So we can expect that to continue to happen. And also to offset a little bit land prices, commodity prices for corn and soybean have decreased compared to two years ago. So that lower prices in these commodities are reducing the profitability of the land in the rest of the region except Argentina. So for Uruguay, Brazil and Paraguay, we don't expect prices to increase. We do expect, as we've been telling some calls ago, prices to go down in terms of the land, and that's something we've been seeing.

Very helpful. Thank you, Mariano.

Isabella Simonato, Merrill Lynch.

Thank you for the call. So I have a question on sugar and ethanol. You mentioned in the release that you've been holding inventories of ethanol to sell in the inter harvest where scenario is only better, but I'd like to understand better your view for this year specifically when we have potentially taxes coming back. For the sector what would be in your view the impact on prices and in your view also on sugar prices going forward? Thank you.

Hi, Isabella. Good morning. Thank you for your question. I going to ask Marcelo Sanchez, our Commercial Director to take this question. Marcelo?

Hi, Isabella. Regarding the taxes that are expected to be coming in, the PIS/Cofins tax specifically in the ethanol, we understand that short-term prices may have had a positive result to compensate part of those charges that are coming. And of course, as these fiscal things will be in place by January next year, starting in place by January next year most probably, the increase in the seasonal price of ethanol will be compensating that increase.

Regarding the ethanol view, the sugar view in our -- in the part of our question, I think that we are very positive for 2017 and we do think that we are going to be enjoying good prices for next year.

(Operator Instruction) Javier Martinez, Morgan Stanley.

I would like to ask you if you can please share with us a little bit about the mood at the Board level regarding what you should do with the cash that you are going to generate this year and the following year. I'm trying to understand if the mandate you have is a consensuated mandate, there is a debate on the Board? I want to understand the thresholds at which point if you can find the internal rate of return that you're looking for, you will start to pay dividend. I would like to understand to try to map a little bit how it's going to be that decision or when may we see a dividend coming on the table.

Thank you for your question. Yes of course, this is a very important matter and is an important discussion that we are having at the Board and it's a matter that of course we are always addressing. So number one, we have a clear idea that for this year cash flow, we are going to be reducing debt. So we are -- we will be certainly reducing debt as the first step and then after going below the two times EBITDA or a certain -- it's not one specific number, but after we are reducing debt that's the first step.

Then the second one is the discussion we are having every time whether there is an accretive growth project or we will start giving dividends or buying back shares. So those alternatives are always in the table and we are always comparing any of the growth project with the alternative to either give dividends or buy back shares. So will depend on what the projects that are presented or the IRRs that we are presenting in the project are accretive or not. So that's basically how we think at the Board level.

Obviously this is my opinion, but let me question that decision because at the end of the day you have a cost of leverage that is pretty low, below 7% in Brazilian reais, 5% in US dollar, but with a capacity to generate higher return on that and with a loan to value that is pretty low. So why to reduce debt, why don't you buy shares or pay some dividend?

Okay, I understand what you are challenging. This cost of debt is what we have because of the growth projects that we had in the past. So that's what we ask with this level of debt to build what we built as a company, so to build basically this sugar and ethanol cluster. So from now on after we review some of the debt level that we have today, we will start doing what you're saying or thinking that way.

Again, sorry to be a pain but you have low cost of production, you have quite liquid high-quality asset, you have a cost of debt that is pretty low, it's been below interest rates in Brazil and you have the share prices trading with [this company's] net asset value. So the Board -- so is this a consensuated view in the Board and that is the best use of the money?

This is of course a discussion that happens at the Board level. And as of now we have agreed that the first step is still reducing debt because we feel comfortable in this business that is a volatile business where you don't have full control of weather and commodity prices. We feel very comfortable with a lower level of debt.

Okay. Understood.

Viccenzo Paternostro, Credit Suisse.

Thanks for the question. My first question is on the planning for the planting of the next season. I'd like to understand whether the potential La Nina could change your strategy for planting in the next season. I mean, we know that La Nina can severely affect the yields in Argentina. So what's your view on that and how this could change your planting strategy? That would be my first question. My second question is on the land transformation. Adecoagro has been selling $5 million to $10 million of land every year. I'd like to understand why that this is going to be the case for this year and for the next year? Thank you.

Okay. So, regarding your first question on La Nina, we understand that today the index is in a week La Nina. That would certainly benefit our crops. That would mean that we would have a relatively dry weather in order to be able to have a good harvest on sugar, ethanol and energy operation. So that would be welcomed for our own business and our own cash generation. And then, regarding corn and soybean planting for Argentina, we are in a very good situation of humidity all over the farms. So we will be able to plant in good conditions and we expect with a weak La Nina to continue having very interesting yields in both.

Whether we are going to be planting more or less, we are growing a little bit in corn and soybean as the returns have improved. And in terms of sugarcane, we continue to plant sugarcane and we continue to grow in order to be on the secure side and being able to have enough cane to continue milling at full capacity as we've been doing in the past two years. So that is our strategy regarding this week La Nina that we are seeing today.

Then on the second part of your question -- on your second question, we've been selling and generating some way more in the last 10 years at $5 million to $10 million. It's more in $15 million to $20 million. And we expect to continue to be, more or less, in that same range. And we are analyzing the sale of the farms according to its return on investment and we are always very disciplined on the analysis of the return on investments, either for buying or selling any of the assets.

(Operator Instructions) Showing no further questions, this concludes our question-answer section. At this time, I would like to turn the floor back to Mr. Bosch for any closing remarks.

So we are now in a very important time of the year in sugar, ethanol and energy business. We are in the most important period of the cane harvest. And in the farming and land transformation, we are entering into the main planting season. So we have all our teams highly motivated and focused on execution. That's how we see our business and the key of our business to focus on execution. So we hope to see you in our upcoming events and thank you for joining the call today.

Thank you, this concludes today's presentation. You may disconnect your line at this time and have a nice day.