Earnings Call: H1 2015

Aug 31, 2015

Good day, everyone, and thank you for joining us today to discuss First Pacific's 2015 first half financial and operating results. We hope you have been able to get a copy of the results presentation, which is available on First Pacific's website, www.firstpacific.com. For today's conference call, we have with us Mr. Manny Pangilinan, our Managing Director and CEO, Mr. Edward Tortorici, our Executive Director, Mr. Chris Young, our CFO, Mr. Paul Wallace, CFO of Goodman Fielder, and other senior executives. At this point, I would like to turn to Mr. John Ryan from Group Corporate Communications for his presentation. Thank you, Sarah. The document we're looking at on the front of it says First Pacific 1H, 2015 Results Presentation. Turning the page, it begins with an important notice. For practical purposes, if you see a dollar sign in this presentation, it's U.S. dollars, unless it's stated otherwise. Turning to page 3, you've got photographs of many of the people who are on this conference call with us today. Page 4 is a reminder of First Pacific's major investments and the areas of business that they are located in. As you can see, I don't think most of you need a reminder. They're either very large or monopolies in their operations. Turning to page 5, we've got the contribution and recurring profit, which is led by turnover down 2% at $3.33 billion. That's largely because of the 10% depreciation in the rupiah average exchange rate over the first half of the year. Rolling down towards total contribution, you can see that's illustrated in the two charts on the right-hand side of the page. The top chart shows historical over the past few years, and the bottom chart shows the different pieces, how they changed from the first half of 2014 to the first half of 2015. Overall, contribution's down 4% at just under $250 million, down from about $258 million. That's led by a decline in the contribution from Indofood, which you all know is due to lower palm oil prices and the aforementioned weak rupiah. PLDT's contribution is down. We'll go into more detail on these companies in a moment. Largely because the fast-growing data-centered businesses have lower margins than the declining traditional businesses, legacy businesses, such as international voice and texting. Then we've got Philex's contribution down largely on lower metal prices pushing down their revenues, and that rolls down to their contribution to First Pacific. FPM Infrastructure, you may recall, was our share of a toll road joint venture in Thailand, in Bangkok. We sold that stake to MPIC in 2014. PLP, our power plant in Singapore, is facing continued wide disparity, wider than expected, between the prices of liquefied natural gas and piped natural gas in its market. MPIC's contribution is up quite a bit, almost $11 million. It has strong growth in all of its four major businesses. Lastly, we've got our first-ever contribution from Goodman Fielder. The transaction was completed in the middle of March this year. As Sarah mentioned, we have Paul Wallace, the Head of Finance and Operations at Goodman Fielder, to give you all a rundown in the Q&A of how that company has performed under our first few months of management. If you turn to page six, you have a snapshot of our balance sheet as it stands today. The key difference really between six months ago, the end of 2014 and today, is that the large cash balance we had at the end of 2014 has now been spent on the final transaction costs of the Goodman Fielder acquisition. There is a little bit of new borrowing there as well. Of course, in the meantime, maturities have shortened in the fullness of six months going past. The blended interest cost remains low at 5.4%. Maturity is 4.3 years. All the data here is in the bullet points and then graphically illustrated on the right-hand side of the table. Given the volatility in emerging market currencies that we have seen over the past several months, please take reassurance in the fact that a full 82% of our borrowings are fixed cost. So we have some stability in the money we are paying out, notwithstanding the dividend payments we receive being affected by weakening rupiah and, to a lesser extent, peso. Let us look at the operating companies, beginning with PLDT on page seven. As mentioned, they have got a slight dip in revenues owing to the contrast in margins between the faster-growing revenue streams and the declining ones. That rolls down to core income down 5% at 18.9 billion pesos. The margin, as indicated, is down two percentage points at 44%. The change in service revenues is graphically illustrated in the middle chart on the right-hand side of the page. No surprise, the red columns are in the more traditional businesses. Looking towards the full year for PLDT, we are expecting CapEx to be higher than they originally indicated at 43 billion pesos, rather than 39 billion indicated by PLDT when they reported their full-year earnings last March. The forecast for core income for the full year 2015 remains unchanged at 35 billion pesos, down about 6.4%. Turning to page eight. The newest of our larger investments, Goodman Fielder, had basically flat earnings in the first, pardon me. We are talking full year numbers for Goodman Fielder here. Their fiscal year end, I think for the last time now, has been on June 30, and they are moving to a December 31 year end. Paul Wallace will interrupt to correct me if I am mistaken. In any case, their full year numbers are illustrated on the right-hand side. Those figures are in Australian dollars, please take note. The New Zealand and international operations performed strongly in New Zealand, largely because of a beneficial movement in farm gate milk prices, boosting margins in the dairy business. The international business, which I am sure Paul will talk about, saw good strong growth as well. The Australia business, as has been the case with Goodman Fielder in the recent past, has had difficulties, particularly in the bakery business. But, as will be discussed in the Q&A, we've seen some significant cost saving and efficiency improvements, which we have already begun to implement. We can see all of that quickly beginning to roll down to the bottom line when we next report on Goodman Fielder for the full year earnings. Now let's turn to page 9, Indofood, our second largest investment and our biggest investment in the food business. Essentially, as ever, Indofood has delivered stronger revenues in local currency terms. But core income hurt quite a bit by lower CPO prices and a weakening rupiah, making imported sugar and wheat and milk powder more expensive in local currency terms, pushing core income down 8% to just over 2 trillion rupiah. Those numbers worsened in USD terms, as you can see in the third bullet point there. Now, the first half numbers if you drill down into them, show strong sales growth in every business under Consumer Branded Products. A little bit of weakness in the flour business. Strongish distribution, and as mentioned, the agribusiness hurting from low commodity prices. That picture is probably more or less going to remain true for the full year. We do take note in recent weeks since the end of June that the rupiah has weakened significantly. I think Joseph or Chris Young, our CFO, might speak to our exchange rate expectations in the Q&A. Now let's turn to page 10. Metro Pacific delivered the strongest results in the first half of the year. As you can see, all of their businesses on their own terms did extremely well. That slight red mark in the contribution evolution chart on the bottom right-hand side under hospitals is slightly misleading because we sold 40% of that business to GIC of Singapore, which automatically, of course, drills down to a lower contribution to MPIC, notwithstanding the strong earnings growth there in that business. The toll roads business saw very strong growth, close to double digit, in one or two cases, 11%, I think, in traffic growth. We're seeing that trend continue as we move into the second half of the year. The power business benefited from continuing economic growth, slight increase in demand, and greater retail electricity sales, as well as contribution from smaller operations. Manny, who's chairman of Meralco, might speak to that if you've got questions during our Q&A. Now the rail and automated fare collection system, they show a negative number because they're investment start-up phase. But over the next few weeks, those businesses, we are hopeful, will begin to get going, depending to a certain extent on action by the Philippine government. Now, MPIC for the full year forecast, its core income at 10 billion pesos, up quite strongly from 8.5 billion pesos in 2014. It's got a large handful of new projects that is beginning to work on so that its strong growth will continue well into the medium term. Now, let's turn to page 11, and that's Philex, the last of our major holdings. To no surprise to anyone, their earnings are down simply because copper prices and, more significantly, gold prices are lower than they were a year ago. That pushed revenues down by more than one-sixth to 4.89 billion pesos. The core income was down to a lesser extent, at 520 million pesos. The lower revenues pushed that down, but it managed to salvage some cost rationalization to make that number rather better than the decline in revenues. Looking ahead to the full year, it looks like Philex is going to have a similar sort of outlook as in the first half of the year. Its major project down in the south, the Silangan Project, has got work carrying forward on its definitive feasibility study, which is the document key to further development of that project, and we might answer some questions on that as well. Regarding the continuing mining operation in the north of the country called Padcal and Baguio, there is some fairly optimistic exploratory work on potential new mineral resources in that region. The remainder of this presentation consists of some tables with a contribution summary on page 12. I won't read it to you. You've got it there in front of you. That's followed by a consolidated statement of our financial position. Those of you who know us well understand that we tend to focus more on head office numbers rather than the consolidated ones. Then it ends with a head office cash flow table on page 14, and then an adjusted NAV per share. I would imagine that some of you would want to ask about the increase in our NAV discount from the end of 2014 to the end of June. I personally am a bit nonplussed by that, and I think it may be something of a market failure, notwithstanding the exit of over $1 trillion from emerging markets over the past few months. In any case, this winds up the opening narrative of our first half results, and we can now move to Q&A. Operators, we are now ready for the questions. Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that is star 1 to signal for a question. We'll go first to Mark Webb with HSBC. Hello. Good evening. Thanks very much for the conference call. My first question, just on Goodman Fielder. Obviously, a new business, it is quite difficult for us to understand the prospects of this organization. Maybe you could just provide a bit more information about how the restructuring reorganization program is going, how you are trying to tackle some of the weaker business in Australia such as the bakery business, and what do you think the prospects are for the second half of this calendar year and looking into 2016? Paul, could you take that, please? Yeah. Hi, Mark. Look, I think we have had this business now for about six months. We have changed all the senior management. We have changed all the reporting structure. It was previously run on a very complex or matrix organization, and we have got everybody focused on a country basis. We have got Graham Pickles, who has previously worked for the group and has been very successful in other distribution businesses. He is involved with the international export business and is overseeing the Fiji business and the Papua New Guinea businesses, which are both very profitable. I think we are expecting the completion of the expansion of the UHT milk plant in Christchurch to happen on schedule in October. Actually, the sales team that Graham has put in place in China with the help of Wilmar, have been so successful in the last two months that this month they are actually having to ration the sales of milk into China. They seem to have cleared up all the issues that they had in the past with clogging up the channels. So I think Graham is very optimistic about milk sales into China. We have also started shipping for the first time other branded grocery products. But to ramp this up properly, this is going to take a while. I think we see the second half of 2015 to just be spending time getting everybody ready so they can have a running start at 2016. We've told people when they did their budgets for this year, which were just completed in June, that they needed to make sure that they'd allocated enough resources so that they were ready to go for 2016 at full blast. The big Australian business, which has been troublesome, has been fresh baked bread, where the turnover is about AUD 600 million a year, but we make pretty much no money out of it. The approach to that is we need just to keep to find ways to take cost out. We're in discussions with other people in the market about how we might change the logistics model. We're talking to the supermarkets about how we might need to change the logistics model. We're looking at ways of taking material cost out. We're looking at ways to reconfigure the footprint of the various plants. Realistically, the sliced loaf business in Australia is never going to be a big winner. To some extent, it's the same story in New Zealand. The key thing in New Zealand will be to help with the export of dairy products, and we're pushing ahead for the first time with the export of more yogurts and cheeses. Again, on the baking side, which is mainly a domestic market, the concentration is to take costs out. We've hired a new logistics guy in Australia who previously ran logistics for Coca-Cola in Australia. We've hired a new logistics guy for New Zealand who previously ran Unilever's logistics around Southeast Asia. We just hired a new country head for New Zealand, which is previously a very senior person with Fonterra. We've been very lucky to get a very senior person from Woolworths to join us in Australia to head up that country. As I said before, Graham Pickles has gone around and appointed new heads for Fiji and PNG and is building up the export team both in China and building up the base in Singapore. I think we're just going through, for the first time with this crew, the three-year budget program, and the expectations are that the budgets will be finished in October. I think at the moment, one thing I would say is that we haven't found any ugly surprises when we've looked at things. We've seen more opportunity than we had previously thought. There's been one or two messes that have had to be cleaned up, but for the most part, I think everybody's pleasantly surprised that what we're finding seems to be more opportunity than peril. Great. Thanks very much, Paul. I know this is a difficult question, but can you put any sort of targets? Do you have any sort of financial targets you can tell us about for second half of 2015 and into 2016? Well, I think 2015 is not going to be that exciting because we really have asked people to make sure that they've got things spent on resources. I'll give you one example. The amount of money that we should be spending on advertising and brand promotion. Historically, the previous management was always worried about meeting targets, had really cut this back to the bone. In some markets, it was less than half a percent of sales, and it should probably be 10 times that. So we've asked people to budget on the basis that there's going to be a much more normal advertising spend. That probably meant there's been quite a bit of catch-up. What I would say, without giving you any specific numbers at this point, is that all the initial indications are that we will be achieving the acquisition model earnings for 2016 and 2017. I think that 2015 is going to be a bit of an odd year. We've changed around the management. We've told people to make sure that they're investing in brand support and new product development. I think that's what people have to think about when they look at the outcome for 2015, that it's really trying to get people ramped up so that they can really have a running start at 2016 and 2017. Okay. Thank you for explaining. We will take our next question from Karl Choi with Merrill Lynch. Hi. Three questions here. First one, again on Goodman Fielder. I noticed the discussion about the 7.8% EBIT margins in the second quarter. Not knowing if there is a lot of seasonality, but it does seem like it is quite a bit nicer than what they were reporting previously. Was it just because of input costs and it looks like some of the savings that you are talking about are yet to come that will be on top? Or are we already seeing some of the input costs and some of the cost synergies coming through? That is the first question. Well, I think that there was a number of things that sort of affected the last quarter, and some of it was just the way that we cleaned up the accounts. I think that starting from June, you will see the effect of some of the cost-saving side to come through by the end of the year. But the full benefit is not going to be 2016. There are all sorts of things that we are looking at at the moment. Changing packaging, for example, changing the pricing of plastic bags for loaves of bread. I know it does not sound very significant, but given that the packaging and the materials is about a third of the total cost. So if you can knock some money off that on a full year basis going forward. Because of the existing contracts that are in place with a number of people, it typically takes you somewhere between three to six months to be in a position to start realizing identified cost savings when it results in changing who you are buying your contract labor from, or changing where you are buying your materials from, or when you are changing your packaging. So there is a delay. But what I would say is that, we have got a team of people who do nothing else now but go around and identify cost-saving opportunities. But the one that will be more immediate is where we are actually reducing, there is a number of programs in place to reduce the amount of waste in the manufacture of bread in Australia. Which used to be, by one measure, used to be 16%, and we've reduced that by about a third, and the target is to keep pushing harder to get it reduced even more. On an annualized basis, that could be significant. The trick for us is to ensure that all these cost savings we get to keep, and that they don't leak out somewhere, or the worst case is that the major customers find out that we've got some logistics cost savings and that in the typical Australian environment, they will insist that they share in those sorts of savings. I think that it's going to be very important for us to fix what we can fix internally and make sure we hang on to it. Okay. Great. No, appreciate it. Second question is on FPM Power. Just looking at the first half results, losses increase year-on-year. Just wondering what the outlook is for the second half. Should we expect losses to still be up year-on-year on the second half? It's Robin here. I'll have a shot at that. I think the first half was badly affected by the differential pricing between LNG and PNG. That's always a factor, but it was particularly bad at the beginning of the year. I think for the second half, retail sales look a bit stronger, and we've been able to make some savings in the cost of LNG, which is our fuel, by buying some of it on the spot market. So I think the slightly disappointing first half is likely to be recouped to some extent in the second half, and we're looking at materially higher performance, both in terms of core income and in terms of net income. The second half will, we hope, be a bit better than the first half. Do you think you'll still be generating losses in the second half? Yes. I think we're expecting losses this year, and realistically, the budget reflects the fact that we think there will be losses this year. Okay. Last question. Just want to find out, in the headquarter cash flow statement, the dividend and fee income. Apart from dividend, was there a very meaningful fee income in the first half? Because the amount, $183 million, was quite a bit larger than last year's, even though I think earnings and I think the dividend declared by most of the investments was relatively flat year-on-year, except for Indofood. Just trying to figure out why the big increase there. It's Joseph here from the treasury side. It's mainly a timing difference in respect of the collection of the Indofood final dividend for the fiscal year 2014, because there's a kind of a new rule done in Indonesia Stock Exchange that they need to pay the dividend within a certain time limit after they hold the annual shareholders meeting. So that's the main change, because in the past, we normally receive the dividend from Indofood in somewhere around August in the second half. So it's mainly the timing difference. Other than that, there's actually no significant change from last year. Of course, if you take into account, say, dividend income from other units like PLDT, and clearly the dividend from PLDT dropped a little bit in the first half of 2015 because they have a kind of a lower recurrent profit in respect of 2014 versus 2013 when they declared a final and special dividend. Of course, the peso exchange rate is a little bit down in the first half of 2015 versus 2014. So that kind of increase as reported in the cash flow statement is mainly because of the timing difference attributable to the collection of Indofood dividend in the first half. Okay. Got it. Great. Thank you. We'll go next to Eric Soon with Citi. Hi, management. Thanks for taking my question. Just a question regarding the dividends and the share repurchase. We did see after the acquisition of Goodman Fielder, the net debts of the head office increased a bit. But given at this level, we did see a deep NAV discount. Just want to see if management have any considerations in how to balance the dividends and the share repurchase in the future. First of all, let me start with dividends. We've repeated the dividend level for the first half of the year that we had for the first half of last year. We've maintained the dividend for the half year when compared to last year. How we calculate for the second half will really depend upon what happens to exchange rates and other factors which affect our overall results. Of course, we'll continue to pay at least the rate of 25% of our core profit. Whether we can do better than that will depend entirely on how things look. It's a sort of look back approach that we've decided to go with. Slightly cautious in a way because currencies and markets are extremely volatile at the moment. But we will certainly meet the minimum of 25% of core income paid out as dividend, and I dare say we'll do a little bit better. But I'm slightly unwilling to say more than that given the volatility in markets generally. Now, turning to share repurchases. We've had mixed success with share repurchases over the last few years. It's been very difficult for us to correlate any significant share repurchase with a reduction in the NAV discount. I think what we expect to concentrate on over the next few months is tackling our debt. It's not dangerously high by any means, and it's certainly within our forecast. But I think to the extent that we have spare funding, we intend to look at bringing our debt down, and that's the priority. So ensuring that the dividends meet our dividend targets is one priority, and then trying to bring the debt down if we have spare funding is the second priority. I don't think, given the cash flow that we have available for discretionary spending, there's going to be much emphasis on small share repurchases, simply because our experience over the last couple of years has not been very promising on that front. All right. Thanks. That's very helpful. We'll take our next question from Mark Webb with HSBC. Hello again. Just two questions, just sort of quite broader questions. Firstly, in the Philippines, how do you characterize the regulatory environment in the period up to the presidential elections? Is it likely to remain very tough, and do you expect any progress in terms of the tariff increases? Secondly, Indonesia. What's been so surprising in Indonesia for me, looking at a variety of companies, is just how weak demand has been, even in quite staple products. The question is: Are you seeing any change in that demand environment coming through, looking at your businesses? Well, in terms of the regulatory environment for the balance of the Aquino administration, I would say there's been no significant change in that environment. There's been perhaps some slight improvement and maybe a more positive attitude towards the business. That's a tough one to call. We continue to put quite a bit of persuasion on the government to get, for example, the tariff increases on the toll rates to the point where we've signaled that we might take some harsher actions to get the toll rate increased. But I think overall, I would say that it's just a slight improvement in the way things are managed by this government. We received approval to increase the water rates to the account of the consumer price index. We managed to get the changed tariff of Meralco pretty quickly with the Energy Regulatory Commission. Toll rates has been difficult so far. That's quite difficult to predict. It's sort of a mixed signal from this government as to whether in the waning months it will continue to improve. I think that remains to be seen. I think that said, we're quite happy that the business continue to be managed well. We're happy that the volume of water sold, of electricity sold, toll rates traffic have increased despite the regulatory challenges. That's why I think Metro has done well because of cost control and the volume sold of its various units. Shall I try Indofood? Yeah, sure. I can add a word or two if necessary. Yeah, no, if you could, yeah. Clearly, the overall Indofood position is affected by lower commodity prices, CPO prices. But on the Consumer Branded Products side, generally speaking, volumes have been flattish. But we have seen revenues increase because we have been able to pass on price increases. I do not think that situation is expected to change much in the second half, although certain aspects of the business, dairy, for example, we hope that we will be able to expand sales in terms of volumes. So taken in the round with the caveat that CPO prices are likely still to be weak, we think the second half of the year should be okay. Okay, great. Thank you. We will go next to Jeremy Yeo with Mizuho Securities. Mizuho. Please check your mute button. Jeremy? Your line is open. Hearing no response, I will clear the question. At this time, we have no further questions in the queue. As there are no more questions, may I invite Mr. Pangilinan to give his closing remarks? Well, thank you for joining this call. Look forward to talking to you again, I think, in the investors briefings. We'll be at the CLSA conference on 16th and 17th September. Manny will join us there. Chris Young and I, John Ryan, will be at the Deutsche conference in New York next week, and we're hoping to squeeze in a day in London as well. London-based investors will get word of that if we can confirm it. Thanks, John. Thanks again for joining today's call. To provide the replay information. Thank you. Ladies and gentlemen, to access the replay of today's call until Monday, 7th September 2015, you may dial the HK toll-free number of 852 3008 0334. Callers from Singapore may dial 800 101 2009. Callers from the U.K. may dial 0808 101 1153. Callers from the U.S. may dial 888 203 1112 with replay passcode 3539202. Again, ladies and gentlemen, we thank you for your participation. You may now disconnect your lines.