Earnings Call: H1 2017

Aug 30, 2017

Good day everyone, and thank you for joining us today to discuss First Pacific 2017 first half financial and operating results. The results presentation is available on First Pacific's website, www.firstpacific.com. For media on this call, please note the Q&A session is open for investors and analysts only. If you would like to raise questions, please contact us when the call finishes. For today's conference call, we have with us Mr. Manuel V. Pangilinan, our Managing Director and CEO; Mr. Robert Nicholson, Executive Director; Mr. Chris Young, Executive Director and CFO; Mr. Ed Tortorici, and other senior executives. At this point, I would like to turn to Mr. John Ryan from Group Corporate Communications for his presentation. Thanks, Sarah. Good evening and good day, folks. This presentation, currencies mentioned will be U.S. dollars unless I tell you otherwise. Let us turn to page 3 of the presentation, which hasn't changed in a little while, but there's a large change at the top where you can see that Ed Tortorici, who's been a director of First Pacific for a quarter century or so, has retired. He'll continue as a consultant for some time. And he's replaced by Chris Young, who's been in the First Pacific Group in one role or another in our various companies for over 20 years. A century, yes. Yeah. Yeah. Most recently as CFO at First Pacific. He's been appointed from the end of today's board meeting, and the senior supporting staff on the bottom row have not changed. Turning to page 4, there's a snapshot of our larger and more important investee companies. So far this year, our ownership in these assets has not had any kind of meaningful change. Now if you turn to page 5, there's a snapshot of the value of those investee companies as of the end of June. Our GAAP then was about $7.8 billion, divided, as you can see in this pie chart. Telecommunications, about a quarter. A bit smaller than that, investment in MPIC, the biggest infrastructure company in the Philippines. Our food investments with the very strong growth in Indofood's share price over the past 18 months or so has grown to be rather larger than the other individual areas of investment. On the right-hand side, our investment objectives have been slightly updated to introduce a bit of visible emphasis on ESG criteria. As we have seen that the environment and social and corporate governance matters are increasingly important to our shareholders in the wider investor community. We published our first ESG report about a month ago, and we are happy to talk about that in the Q&A if you would like. Investment criteria really not changed. Page 6 has our traditional larger pie chart showing the full valuation of the assets that we are listed in, and one or two assets below that level, such as Meralco. Overall, they are about $35.5 billion, with proportions not too dissimilar from the GAAP pie chart on the previous page. Now let us have a quick look at our earnings for the first half of the year on page 7. As we have suggested in our meetings with investors over the past few months, our contribution from these investee companies is up in the first half of the year, and we expect that this will herald an increase in contribution and recurring profit and net profit for the year as a whole. Looking forward over the medium term, we are confident that our group of investments will produce steadily stronger results going forward. That will mean for First Pacific, steady earnings growth after two or three years of decline. That, we are hopeful, will result in an upturn in our dividend income perhaps as early as next year. With the caveat, of course, that this does depend to a great extent on exchange rates. Let us note that the Philippine peso is down about 6% in the first half of the year. Now if you look on page 8, there is some important information there about our cash flow and debt profile. With us on this call is Joseph H.P. Ng, our very patient and hardworking Head of Treasury, who over the course of 18 to 24 months, has brought us significant reductions in the size of our interest bill and the size of the overall debt outstanding. Whereas we are now in a position where, as you can see on the bottom left chart, we have no debt obligations due until 2019, when one of our first bonds matures. If you look at the chart above that describing our cash flow, there has been some condensation of data here, net loan repayments being the biggest figure on that chart. That is consisting to a great extent of bonds that matured last month in July. It was our most expensive borrowing at 7 and three-eighths. We are very glad to see that interest bill go. Please note the dividend and fee income there does not contain a very large payment from Indofood. Let me remind you all that Indofood pays its dividend once a year. It is generally in the first half of the year. Because of the Muslim holiday calendar, for one reason or another, the company could not get approval from its shareholders for payment of that dividend until the first week of July. That came in about $69 million. So that closing free cash of $58 million you see on the right-hand side of that chart is a little bit misleading. As of now, we've got, double or 1.5 times that amount of money currently in cash right now at head office. We are hopeful that 2017 will mark a low point over recent years of our dividend income, with 2017's improved results by the operating companies resulting in an uptick next year of dividend income to First Pacific. Again, please note that this does depend on some stability in exchange rates. Now, just a quick note on those two pie charts at the bottom. The unsecured share of all of our debt outstanding is now about four-fifths of the total. We've made significant strides towards pushing that up towards our eventual goal of 100% of all our debt being unsecured. Now, let's have a quick look at how those operating companies performed. Indofood, on page 9, saw its revenues rise quite strongly, mostly because of the consumer-branded products business and the agribusiness delivering strong growth, followed by distribution. Bogasari, of course, hurt by lower wheat prices, which reduced its own contribution to the overall company. Bogasari being the flour and pasta division of Indofood. Now you see core income, notwithstanding how this chart appears to show a steep increase, it wasn't up very much. It was mostly flat, and that's because of the Muslim holiday calendar that I referred to, which meant there were lower sales towards the end of June than you usually see, and there will be a corresponding uptick in the 2H numbers for Indofood. So the full year results at Indofood will very likely be rather stronger than the half-year numbers you see here. Now, as the biggest food company in Indonesia, they face quite a bit of competition, but we are very happy to record that in the first half of the year, nearly all of their businesses, except for Bogasari, saw stronger sales. Now, within consumer-branded products, which as you see on page 10, is about half of all their sales. The dairy business did have a bit of difficulty with milk prices, but going forward, it seems that the strong sales growth we see in all the product categories there, from noodles to snack foods to dairy and beverages, will continue growing quite well. As you can see in the very large chart on the left-hand side of the page, we've had a 1 percentage point increase in the EBIT margins overall, driven clearly by the agribusiness, where much stronger palm oil prices drove a sharp increase in the EBIT margins there. Now, palm oil prices are quite cyclical, and we will see in the second half of this year that they'll be down a bit from the first half. But to some, Indofood will have rather better results for the full year than we've seen at the half year. Now let's turn to page 11, where we've got that fascinating story of the PLDT turnaround from the old, stodgy business of, as Manny was saying in the board meeting earlier today, they only sold one product, and that was voice. As you can see on this chart, big on the left-hand side of page 11, that voice, which was their only product a few years ago, continues to decline quite strongly. Their second-ever product, texting, continues to go down. As you can see, the recovery is being led by revenue from data services. These, of course, are lower margin businesses. We are on a secular trend of margins coming down, and the aim at PLDT is to turn it towards revenue growth, which we would hope to see perhaps next year, leading as our primary goal to earnings growth going forward. Apart from the earnings, the most visible aspect of PLDT's earnings report for the first half of the year is that they have sharply reduced their forecast of CapEx spending from PHP 46 billion to PHP 38 billion. This, quite honestly, is simply that that sheer volume of CapEx work cannot physically be done in the time that they would have budgeted that. A lot of that work is being pushed through into 2018. However, their CFO reiterated to our board earlier today that they do expect to have LTE, that very important 4G technology, reaching 70% population coverage as planned by the end of this calendar year. PLDT is very confident when they say that their mobile network is much better than Globe's, their main competitor, in terms of download speed and quality of their connection. Globe still has an edge in terms of breadth, but that edge is declining quite rapidly as our CapEx spend goes out. Let us move on to Metro Pacific. The biggest infrastructure firm in the Philippines. Page 13 has a reminder of the main investments that Metro has. I don't think there have been any major changes this year. They are up to 13 hospitals now. A business that began in 2008 with a small investment in one hospital. Their road investments there on the left are much the same. The bulk of it in the Philippines with a little bit in Thailand. Very profitable investment there in the Don Muang Tollway. Also in Vietnam, the CII Bridges and Roads. Just over a year ago, there was that big change in their electricity investment, which is reflected in the addition of Global Business Power to their portfolio. More recently, in the first half of this year, they have increased their stake in Beacon Electric to 100%. You will see that when they report their full year numbers, in fact, they may have done that in the first half, Beacon Electric is fully consolidated now. Page 14 shows you a comparison of how the contribution has changed from the first half of 2016 to the same period this year. Essentially, we have got continuing very strong earnings growth at Metro Pacific, and that has been driven by a bigger investment in electricity, very strong growth in the toll roads, stronger contribution by hospitals, however small a share of the total it is. The water contribution held back to a certain extent by lower temperatures than we saw in the same period in 2016. There have been some positive developments on what seemed to be the never-ending story of disputes over tariffs with various regulators. Manny can fill you in on details about that. It looks like there is visible progress in Maynilad Water Company's quest to sort out its tariff issues with its own regulator. For the full year, Metro Pacific will again, as in the previous few years, have very strong earnings, and we are very confident that the future there is quite bright. We're looking at economic growth in that company continuing to deliver increasing demand for electricity and services like roads and hospital and so on that Metro Pacific offers. Now if we turn to page 15, Goodman Fielder is the newest major investment that we have at First Pacific. Overall, New Zealand has led the results at that company with strong sales growth. But we see normalized profit was quite disappointing, down 15% to AUD 18 million, owing largely to a decline in the contribution from Papua New Guinea, where they had some difficulties with sales in the second half of 2016 and in the first half of this year. We're looking for a stronger turnaround in the second half of 2017 there. Now newer markets such as ASEAN markets like Philippines and Vietnam are growing very well indeed. So the international business has a very bright future in front of it, notwithstanding the disappointment, the genuine disappointment at Papua New Guinea over that six or eight-month period into the first half of this year. Our colleagues Stanley Yang and Robin Nicholson can speak to this in the Q&A going forward. Now, very quickly on page 16. The last of our major investments, Philex, one of the biggest copper and gold mining companies in the Philippines. They reported a decline in core income because, as you can see here, smelting charges were higher. They also had some higher costs because the ore that was coming out in the first half of the year was in the form of much larger boulders than in the year earlier period. Big boulders cost more money and take longer to smash down into the fine powder that they eventually need for smelting. So that eventually fed down into a slight decline in their core income, notwithstanding a staggeringly large increase in copper prices, which very much helped them. Now, if you want to ask how their core income is down, where their contribution to First Pacific is up in the first half of the year, it's quite simply because of a difference in treatment of the income derived when the metals are produced under the various accounting standards. In the Philippines, you can account for on production, so that ore that was produced late in 2016 was recorded as income that year and not in the first half when it was sold, where it was recorded for First Pacific. So we had an artificial boost in the contribution, as it were, because of the slightly different accounting treatments between the two systems. Now on page 17, the conclusion we've got here essentially is unchanged from the conclusion we had on our full-year earnings report in March. Our NAV discount preys on our minds. It's been high 40s, as much as 50% for too long a time. Though we are heartened to see that after today's earnings report, it's down to about 45% at today's closing share price. And let us hope that we can see some progress moving downward from that level. As said, our investments are well positioned for growth this year and going forward. We expect that this will be reflected in our NAV discount as the market absorbs the confidence that we've got in the prospects going forward. We're identifying assets which don't meet our return requirements. We can speak to this in some more detail. I can see Patrick Millicam, you've emailed me some questions about that. When it comes to your turn on the call, I can speak to them now, seeing as they're in front of us. I'll answer Patrick's questions. He emailed telling you guys what they are. We'll continue on to Q&A, and at the end, Manny will give us a wrap-up. Patrick writes that the discount at 50% is a very poor time to issue new shares. We should buy shares in the market rather than issue new ones. I think what we're looking at here, Patrick, and it's reflected in the cash flow chart that we have got in this presentation on page 8. There are share option proceeds there of $34.5 million. That essentially stems from First Pacific management and staff selling share options ahead of their expiration, which comes, I think, within the next week, September 5 or so. Those are old share options at the price then of about 495. Yeah. Issued 10 years ago. 10 years ago. The options would have expired on September 5. That is why there was a significant exercise of those options. Patrick, you will not be seeing any kind of continuation of that because they are essentially all gone. Yeah, I am not planning on issuing new shares. Right. Now, to your written questions. Do we think the recurring results of First Pacific will rise over the next five years, not only in 2017? Yes, we do expect that improved results at our operating companies over this medium-term period will feed down to us over this five-year period that you named. You referred to the sale of non-core assets and the use of proceeds towards debt reduction and John Ryan's personal favorite, share repurchases. You ask, "Which assets are non-core, missing return targets available for sale? Philex, FPM Power." Stanley Yang, our Executive Vice President in charge of corporate development, I think, could probably speak about what might be available for sale and where things look about that. Yeah. In addition to the two assets that John has mentioned, we would also consider, and we have been approached by interested parties on our sugar business, the Roxas Holdings stake in the Philippines. Whilst it's a very large miller in the country, for us, it represents non-core. As you maybe recollect, we did exit our shareholding in Victorias a year ago. For us, we have been approached. We are looking at our options right now, and it's possible that at some point within this year, we would look at an exit, but certainly only if the right terms and conditions would be available. Okay. Thank you, Stan. Patrick, you go on to ask about the valuations of PLP and Goodman Fielder, as we've described there in the pie chart on page 5. I think Chris Young can tell us about that. I think the valuation that John has used is the cost of our investment, and it may include certain retained earnings from there. Whether the value is warranted, I think we feel strongly that it is. There has been a significant improvement in operational performance since we acquired the business, and we are expecting that to continue into the second half of this year. In fact, there are a number of things that are underway at the moment which would result in improved performance going into 2018 and 2019. It's across the breadth of the businesses. We're seeing improvements in the operations in Australia. We're seeing improved results profitability in New Zealand. As mentioned in John's presentation, while there has been a short-term setback in Papua New Guinea, we're expecting a strong rebound into the second half of this year and improvements as we go into 2018 and 2019. So I think we feel that the amount which is reflected in the presentation for the valuation of Goodman Fielder is fully warranted. I can just add some more color around Goodman Fielder. It is a cyclical or seasonal business, and if you were to look at last year, in 2016, about two-thirds of the profits were generated in the second half of the year. I think this year is certainly the same trajectory, but even more so skewed towards our expectation on the second half, given the challenges of P&G, which for the first quarter was quite challenged. It wasn't operating. In fact, it generated losses during that period. But starting in the second quarter, it has rebounded and the execution problems of the business, looks like they're well on their way to being fixed. Patrick, you also ask about the returns that we're seeking from our new investments. You mentioned from an IRR perspective. Sam, can you give us a hand on that? Sure. The IRR targets for us at the group as well as at the individual companies, certainly will differ depending on the nature of the investment. The infrastructure, for instance, would target teens, sort of low to mid-teens type of IRRs. But with upside, if there are improvements beyond the base assumptions. Certainly in food, we would also look at teen type of IRRs when you look at a 5-year investment horizon with growth in profits and attributing some type of exit terminal value. From our perspective, we do look to make investments that would grow the business, the profitability on the top line as well as the cash flows and then we would look at those during the course of our investments. Operator, we can take questions from other participants. Thank you. If you do have a question on the phone, please press star one on your touchtone phone. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, please press star one if you have a question. We will take a question from Jeremy Yeo with Mizuho Securities. Hi management. I had a few questions, mostly with regards to the operating subsidiaries. Let me ask the first one on FPM Power first. I noticed that there has been a slight improvement on a year-on-year basis. May I ask what is the driver of that, and if that derails your plans that would derail your plans of possibly looking to exit that business? I will answer that. It is Robin here. There are three things I think that have driven an improvement in performance. One has been higher oil prices, which have partly offset the disadvantage that we suffer in terms of our fuel stock when prices in oil are low relative to piped natural gas, which is priced off a different formula. That is number one. Secondly, pool prices in Singapore have strengthened over the first half of the year, partly because there has been a reduction in the supply. Some of the other producers have taken their capacity offline for maintenance. Thirdly, we have been operating more efficiently, so our spark spread has improved. So efficiency, lower supply, and better pricing for our fuel have contributed to an overall improvement in performance. We hope that that will continue throughout the rest of the year. The summer months have been a little bit more challenging. Electricity demand has grown at a slower rate than GDP in Singapore. We hope that will be reversed. No, I think if we could exit the asset on favorable terms, we would do so. The improvement in performance arguably increases the odds that we will be able to find somebody to pay a reasonable price for the company. Great. My next question is actually on ICBP. It sounds like you guys are quite optimistic about the business in general, as you should be. But I did notice that you talked a little bit about increased competition. I would imagine that that pertains more to the snack business and the dairy business, more than the instant noodle business. Although I did notice that there wasn't much revenue growth in the first half in the instant noodles business. Can I just ask if you are seeing competition in the instant noodle business at all? And if it's fair to assume that we should see an acceleration to growth rates in the second half of the year? Hi, Jeremy. John here. Yes, you will see more growth in the second half of the year for very likely all of the different business lines under consumer branded products, largely because of the calendar effect I mentioned earlier. The noodle sales were up a bit in the first half of the year, and that was mostly as a result of higher pricing. They were able to increase their average prices to a great extent because of newer, much higher margin noodle products they are now selling. I should have had my dinner because I'm salivating at the thought of these noodle products, which have what they describe as real meat in them. Just what you need if you're a hungry university student studying for an exam at 3:00 A.M. So yes, we'll probably see some volume growth for the noodles business in the second half of the year. The snacks business saw very strong growth. There was the strongest sales growth in the entire ICBP branch of Indofood, and that's on the strength of the introduction of lots of new products, including one of my own personal favorites, Doritos. For the year as a whole, you would expect very good earnings growth at the CBP division. The only small note of pessimism might be in Bogasari, which very much has its fortunes driven by prices of. Right. Okay. Just wanted a little bit more color on Goodman Fielder. I was actually pleasantly surprised that the New Zealand and Australian businesses seem to be turning around. After kind of multi years of margin declines, this has been a good turnaround. Is this sustainable? And perhaps you could give us some idea about what's driving this growth again. Well, I will address that. It is a series of measures designed to improve the profitability of the business. There is no one single thing that you can put your finger on and say, "That is the key." It includes a complete revamp of the manufacturing footprint. A number of the facilities have been closed. We have teamed up with one of our competitors in Western Australia and combined manufacturing facilities there. We have rationalized manufacturing facilities in Queensland and also in Central Australia to try and improve the overall efficiency of the manufacturing processes. We have completely reworked the distribution arrangements. In fact, to some extent, the bread business in particular is a distribution business as much as it is a manufacturing business. Turning the efficiency of the distribution side of the business around has a big impact. We have improved the efficiency of buying our ingredients. We have been clever about the cost at which the ingredients have been bought in. We have changed, to some extent, the relationship with the supermarket chain, who are the dominant buyers. We have persuaded them to cut the wastage. At one point, one in every five loaves that was manufactured was being returned at our cost. That wastage is now down to 4% or 5%. If you take all of those factors together, you see a very significant and sustainable improvement in the profitability of the Australian division. A similar process is now underway in New Zealand, and we expect to see the full benefits of that coming through over the next 12 months. The only problem, as we have mentioned so far, that we have had to contend with, has been a significant breakdown in Goodman Fielder's PNG operations. That really came down to mispricing our principal product, which is flour. That, in turn, had a number of knock-on effects. We have had to make certain further management changes, and I think it is fair to say that we have reversed the damage that has been done. But it certainly held back the PNG business by six months. We are expecting a strong turnaround across the group this year, and I would be surprised if the growth in Goodman Fielder's business for 2017 relative to 2016, in terms of profitability, is much less than 20%. This is on track for our five-year target, and we are quite optimistic that the business will continue to do well. All right. Sorry, just one more detail. I understand about the improving efficiency, but I noticed that even Australia's revenues are up quite healthily again. Is there any one area that is driving that? There has been a lot across the portfolio. When you look at the business, there have been some new product introductions in the grocery category. This includes the dressings, this includes the in-home baking products. The artisan category continues to fuel some growth. On your question on sustainability, some of the new products, there are going to be some lines and product launches in new categories later this year. Mexican, for instance, is a new area that is a strong grower in the Australian market, and Goodman is going to try to capture that business. In New Zealand, very similar across the portfolio. Also on the dairy side, there have been some new products. Authentic Greek yogurt, for instance, is one of the products that will be pushed into the market. It is products like these that, as the company continues to work on the R&D and the new product introductions, will fuel the top-line growth. For the first time in many years, Okay we have seen a growth in bread sales in Australia, primarily as a result of very strong marketing initiatives. Okay. Well, I understand. Okay, final question would be that it sounds like a very robust and wide-based recovery across all your business segments right now. If I were to force you a little bit, in your three biggest investments PLDT and Indofood and MPIC, which would be the one you would pick that has a risk of disappointing you over the next six to 12 months? Well, not anyone, I hope. We're robustly confident that all will continue to perform well. We would be disappointed by disappointment. Fair enough. Thank you. Jeremy- That's all I got. Okay. Of those three investments, Jeremy, one of them is going through a big transformation. That's probably what you're looking to hear. Thank you. Okay. Thanks. Once again, that is star one if you do have a question on the phone line. Star one for questions. There are no other questions at this time. Thank you. As there are no more questions, may I invite Mr. Pangilinan to give his closing remarks? Well, I'd just like to reiterate what John earlier said, and to repeat what Jeremy asked by way of a question, that we're seeing a recovery story in First Pacific across the board, certainly in Australia through Goodman Fielder, New Zealand and so forth, and even in the Philippines in the case of PLDT. I think both Meralco and Metro Pacific are doing reasonably well and should produce a continued increase in earnings. I think that's the story for 2017. We expect that to continue for 2018 and beyond. That's basically the message for tonight and for the year, actually. Thanks again for joining today's call. Operator, please can you provide the replay information? Thank you, ladies and gentlemen. This concludes First Pacific's 2017 first half results conference call. If you wish to listen to the replay of today's call, for Hong Kong, please dial 852 3008 0334, for Singapore, 800 101 2009, for the U.K., 0808 101 1153, and for the U.S., 888 203 1112. The pass code for the replay is 374 7539. Thank you for your participation. You may now disconnect.