Analysts from North America, good afternoon. First of all, welcome to WH Group's 2018 third quarter results announcement teleconference. I am from WH Group. I would like to introduce to you our members of the management in attendance. First, we have Mr. Guo Lijun, Executive Director, Executive Vice President, and CFO. Then we have Mr. Kenneth Sullivan, Executive Director, President, and CEO of Smithfield. He is mainly responsible for our North America, the U.S.A., and European business. Then we also have Mr. Glenn Nunziata. For our China business, we have Mr. Ma Xiangjie, Executive Director and President of Shuanghui Development. Then we also have Mr. Liu Songtao, CFO of Shuanghui Development. I will now pass the floor to Mr. Guo to go through WH Group's third quarter results. Then we will have a Q&A session. Mr. Guo, please.
Analysts, investors, good evening. Now I would like to report to you our 2018 third quarter operating results. Because of global trade friction and also the changes in the American market and also ASF impact in China, in the first three quarters, our production and sales scale is on the rise, and our profitability on a year-on-year basis had come down. In the first three quarters for hogs produced, there are 15 million, up 0.8%, hogs processed, 40.969 million up 4.3% year-on-year. Packaged meat sold, 2.43 million tons up 2.4% year-on-year. Operating profit or operating revenue, $16.585 billion, 1.8% increase. EBITDA, $1.583 billion , down 9.6% year-over-year. Operating profit, $1.208 billion , down 12.4%. Profit attributable to owners of company, $756 million, down 3% year-on-year. Basic earnings per share, $0.0515, down 9.6% year-on-year. This is because of change in biological asset fair value.
Concerning the market condition in China, U.S., and Europe in the first three quarters in China, hog prices on average was CNY 12.6/kg . In the last month, comparing with that, it's down by 19.2%. For the U.S. hog price, $1.11/kg , comparing with September last year of $1.23/kg , it's down 10%. In the first three quarters for EU hog price, $1.02/kg , and last year it was $1.18, so down 13.3% year-over-year. If you look at the global hog market situation, hog price to different extents came down. As a result this year, for U.S. hog production and also China and European hog production industry, comparing with the same period of last year, profitability came down significantly. This is the major reason.
If you look at the breakdown or distribution, now, for our packaged meat, it is our main business, contributing 53% of revenue and 96% of profit. For hog production or for fresh meat, 41% of the total and 11.4% of profit. For hog production, it accounts for 3.1% of the total and 3.6% of profitability. That affected our overall completion of our profit. Now, if you look at a regional breakdown, China accounted for 33.5% of revenue and 59.1% of operating profit. U.S. accounted for 57.9% of revenue and 33.6% of total profits. Europe accounted for 8.6% of revenue and 7.3% of total profits. From January to September for our cash flow, well, it is stable. In the first half, operating cash flow, $609 million, down 7.3% as compared to the same period of last year. The reason was because of an increase in inventory. Secondly, CapEx.
In the first three quarters, CapEx was $480 million, up $100 million or 28.3% year-over-year. For China, CapEx was $65 million, U.S., $355 million, and Europe $60 million. Europe included some newly acquired expansion of production capacity and revamp as well. If you look at dividend payout, in the past few years, dividend payout was on a steady rise. For 2017, dividend in total was $505 million, 45% of our total profit. This year, interim dividend was $94 million, 18% of our interim profit. Our interest-bearing debt and also debt level are coming down steadily. As of the end of 2018, total was $3.37 billion. That is interest-bearing debt. Gearing ratio 41.1%. That's all in our overall operating results. Thank you.
Thank you, Mr. Guo. Now it's time for Q&A. Can you follow the instruction of the operator to proceed?
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The first question is, in the third quarter, I would like to know more about the RMB depreciation or appreciation. Was there actually depreciation and appreciation in RMB? How big a degree is that? The second question is concerning the overseas business, in particular the U.S. business. I would like to know about the upstream hog production and also the midstream operations. What will be the situation like in Q4 as compared to the third quarter? The third question is about Europe. One year ago, there was the announcement of plan to acquire business in Romania as well as Poland of up to 66.5%. I know that you need approval from the regulator and the authority in order to do that. So far, what is the progress and latest status of this?
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May I know the specific situation in the third quarter, please?
Concerning January to September on average, RMB against USD exchange rate on average was CNY 6.529, and last year in the same period is CNY 6.804. There is an appreciation of 4.05%, and there was an impact on our profit. For our overall profitability, well, there is $225 million of impact. Also for operating profit, there is an impact of $29 million. Net profit, the impact was $23.8 million, and also profit attributable to shareholders, the impact was $17 million. Now, the next question was about the specific situation for the third quarter.
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I am trying to look up from my computer for data in relation to the third quarter. Perhaps my colleague responsible for the U.S. business can take your question about U.S. business first, and later on I will get back to you.
Ken, can you take the two questions? One is about the upstream midstream business outlook in the fourth quarter, and another question is about our acquisition in Poland. I think it's specifically relating to the acquisition of the fresh pork business in Poland.
Okay. First, I would acknowledge that the third quarter was a tough quarter for us here in the U.S. as it relates to the live production business, meaning the farms, as well as the fresh meat business. In addition to the trade tensions that have really disrupted the markets, we have also been dealing with oversupply issues in the U.S. There's a lot of factors, externalities that are impacting us in the third quarter. The third quarter was tough in both fresh meat and the farms. The fourth quarter, I would expect to be slightly better in both segments. In the fourth quarter, historically, that's been a good quarter for us for fresh meat. I don't expect it to be as good as last year, but I do expect it to be better than the third quarter. In terms of live production, same thing.
I think, and this is a little bit counter seasonal, ordinarily you would expect the fourth quarter to be your worst quarter from a live production standpoint, meaning hog prices are at their lowest point, and therefore, you typically see the lowest point of profits or the highest point of losses, depending on what the situation is in the fourth quarter. I would expect that this year, in 2018, the third quarter may actually end up being our worst quarter for live production and the fourth quarter being better. In terms of switching gears to the—
Ken, can we stop for a little bit for translation first?
I apologize. Yes, sir.
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Ken, you can continue.
Okay, I apologize.
No problem.
For the Romanian or the Polish acquisition, unfortunately, the regulatory process has taken longer than we would like. With that said, it is going in our favor, I believe, and we expect good news on that front in the next 30 days. But it is a governmental process and so there is uncertainty to it, but I'm fairly confident that acquisition will finally get closed prior to the end of the year.
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In Q3 of 2018, the exchange rate was CNY 6.7856. In Q3 of 2017, the exchange rate was CNY 6.6776. Because of this depreciation in CNY, as a result, our revenue was reduced by CNY 192 million and our net profit was reduced by CNY 19 million. Profit attributable to shareholders was reduced by CNY 14 million.
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[Non-English content] Ken, it's a follow-up question about hog production profit in fourth quarter. Because we can see from the market future price that the implied return continued to deteriorate in fourth quarter. But you mentioned that fourth quarter should be better than third quarter. Does it mean that actually we already implement hedging practice to protect the profit? And are we going to expect less loss in fourth quarter for hog production? This is my first question. Maybe Ken answer first, and then I ask the second question about China.
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Ken, you can take the question.
Yeah. The first thing I would say is reiterate that the fourth quarter seasonally is always the worst quarter for live production. But as I said, I do actually expect it to be better than the third quarter. To be clear, the fourth quarter has losses. You could look at the futures prices and the live hog prices so far in the fourth quarter and understand that there are losses. We have been hedging and we do have hedge positions. I think that we've got favorable positions to the tune of about $4 or $5 a head in the fourth quarter. Our performance relative to the market prices that you see would be better by about $5 a head in the fourth quarter. 2019, you didn't ask that question, but 2019 at this point looks to be a fair bit better, meaning considerably better than 2018 has been so far.
The only caveat I would throw to that is that it still doesn't show big profits. It shows a sort of marginal loss, a couple dollars a head in 2019 at this point. Those numbers have moved around quite a bit. The threat of African swine fever is real, and that could have a potential impact here on our live production business and pork prices next year.
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The question is about the China business. First question is about third quarter. Can you let us know the volume of fresh meat, frozen meat, as well as packaged meat? I would also like to know packaged meat in China, I would like to know why there is a decline in the operating profit margin. Everybody is very concerned about the impact of ASF in China. Do you think that in the fourth quarter in terms of volume that there can be a recovery?
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Let me give you the details about sales volume. In the third quarter, if you look at Shuanghui sales volume for packaged meat, well, altogether the volume was 430,000 tons, up 0.81% year-on-year. For fresh and frozen meat, total sales volume was 380,000 tons, down 4%. The decline was caused by trade friction as well as decline in imported meat. Concerning packaged meat in the third quarter as stated just now, gross profit margin came down. Firstly, there is a decline in the cost of pork, but for other costs, there is an increase. Besides, in the third quarter, we have increased marketing effort and also our support to the market by means of lowering wholesale price. This again affected the gross profit margin. Besides, we made an effort to improve the quality of the meat.
In the third quarter on a year-on-year basis, there was also an increase in wages. Because of all these reasons, the GP margin of packaged meat in the third quarter came down on a year-on-year basis.
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Concerning impact of ASF in China, we can see that the impact on volume is actually bigger than the impact on profitability because of some sort of volume restriction policy being implemented. Also, as far as the end of August, in the whole of China, we have already found 48 cases happened in certain provinces according to the record of agriculture department of China.
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There was one case happened in our Zhengzhou plant, our business stopped for six weeks and have already got impact of CNY 6.6 million lost.
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If you look at the trend of ASF right now in China, actually, the impact and also more and more cases are still being discovered and there are more and more cases found. We believe that there is still a negative impact. In terms of the degree of negative impact in the fourth quarter, it will be more or less the same in the third quarter.
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As regards the future outlook, of course, there will be impact on hog price. This is because of the possible reduction in the supply of hog. We believe that the hog price will rise in the future period.
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The overall impact of ASF in terms of hog price in 2019, the first one is hog price in 2019 will be overall higher than 2018, and the difference among different regions will be larger and the different regions will have different prices. The overall impact of 2019 will be bigger than 2018.
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Based on the forecast of ASF, we will have the measures as below, and we can report here to all of you.
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We will guarantee our food safety in 2019, and we will purchase the raw materials in the regions have no ASF impact and escape away from the regions have already have the cases happened.
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We will take the measure of the testing. We will extend our testing process into the farm and stop the disease from the transportation and the farm.
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Also, we will purchase our raw material locally to escape away from the transportation and spread out of the ASF impact among different regions.
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Also, we will purchase our raw materials in the industrialized plants in a scaled level and escape away from the purchase from the individual farm.
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We will do the testing before the raw materials come into our plant.
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Also we will do the cleaning and safety measures in our plant according to the requirement of Agricultural Department of China.
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There are also five measures that we will take to guarantee our operations. One is to purchase the raw materials hogs, not from the plants with low price and make sure to guarantee the orders that they and also the scales to meet our requirements and our testing standards.
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We will take measures in different regions. In the regions have the impact of the ASF and also the regions have no impact of ASF, we will take the different measures in different regions to guarantee the food safety and our daily operations.
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This is all the answers to the question of ASF.
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My question is concerning the—
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We believe that there would be a positive growth, but then the extent of growth will be better than the third quarter, but lower than the first half of the year.
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[Non-English content] The question on U.S. packaged meat business. I think the packaged meat margin improving year-over-year in the third quarter. Given the recent belly and ham cost trend, how do we think of the fourth quarter packaged meat margin? Do we see any downside risk on a year-over-year basis? Or we are pretty comfortable with that.
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Ken, you can take the question. It's about the packaged meat outlook in fourth quarter. Ken?
Yes.
Yes.
Sorry, Luis. What was the question?
The question is about the packaged meat business outlook in fourth quarter.
Ok. Well, as you can tell from the results, our packaged meat business has had a pretty good year. Our bacon business in particular has been very strong, and our sausage business has been good this year, too. If you're asking what the outlook is in the fourth quarter, I think that we're going to have finish the year strong in packaged meat. I don't want to give any particular, specific guidance other [inaudible] packaged meat business continue the strategy, which is continue to change the sales mix. Again, if you look at where are volume gains and loses are, we're selling less hams and less cheap hot dogs and were selling more on our bacon products, smoked sausage and dry sausage products and that's been the driver behind of the profitability increase.
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The question is about the packaged meat business. Packaged meat business in the third quarter suffers from a declining profit margin because of other costs. However, pork cost has been coming down. In the fourth quarter, how much low price or low cost pork inventory do you still have? Is pork cost going to rise in the fourth quarter? If you look towards next year, what will happen to the hog price? Also what will be the outlook of profit margin for packaged meat next year?
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Now I take the question of the OP margin of packaged meat. One of the reasons that Mr. Liu just mentioned of the OP margin of packaged meat was about the quality of the packaged meat, that we will increase our pork percentage in ingredients, and this will impact our cost in the pork of the packaged meat in the following months, and the inventory and the price of the packaged meat will impact our cost, and the cost of the pork in the packaged meat will keep flat. Overall speaking, the volume and the revenue of the packaged meat will keep single-digit growth in the next few months.
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The overall OP margin of 2019 will be as follow: hog price next year will be higher than this year, and the cost of our hog feeding will also increase, but we will have our measures to keep our cost. One is to continue our strategy of product mix and we will measure and improve our product mix and also we will increase our pricing. According to these two measures that we take, product mix improvement and pricing strategy, we will hedge the impact of cost. Overall speaking, our OP margin for next year will continue to increase.
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This question is about packaged meat business in China. Next year, profit margin in China of this business segment will go up. I would like to know whether this refers, I mean the increase in profit margin refers to the packaged meat business in specific or it is referring to the overall business including slaughtering. Besides, next year, we are going to see an increase in pork cost. I know that you are going to improve your business by altering your sales mix as well as increasing price in order to offset or counteract the risk. Anyway, pork cost will go up next year, so how much will be this increase?
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In 2019, the cost of pork will increase, but other materials will keep flat. Overall speaking, the cost of packaged meat will increase slightly. We will have our strategy of product mix and also our ASP strategy. We will keep our operating profit of packaged meat, keep flat. Also for the slaughtering business, the hog price will increase, OP margin will drop, but overall speaking, the offset of the hog price and our operating profit of the packaged meat, the operating profit of these two businesses will keep flat for the overall next year.
[Non-English content] So the second question is in the U.S. side. So can management share a comment on the potential implication from the new NAFTA deal, which has been recently signed? What's the implication to the future hog price in the U.S. and the related margins for the business? Also, the fresh pork is under a lot of pressure this year. And going forward, what's the outlook for the fresh pork margin in 2019? In particular, we know that 2017 and 2016, actually, there was high base. But can we compare the 2019 with 2015? Are we comfortable that our profitability for the fresh pork business can actually go back to the level that we have seen in 2015? Thank you.
For your first question, you asked for the potential implication of what? Can you repeat your first question?
The new NAFTA deal.
Yeah, I understand the question.
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Okay, this is Ken. I'll answer the question about NAFTA and fresh pork outlook. Obviously resolving the trade issues with Mexico was important and will be favorable to the outlook going forward. Mexico being one of our largest trade partners in a huge market for hams in particular, which you've got 50 lbs of ham coming off of every hog. I will pause here for a minute just for translation.
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Overall, the trade tension issues in 2018 have had a significant psychological impact on the markets, and that has translated into our P&L. I repeat that resolving the issues with Mexico are important and hopefully we can get issues resolved, or the U.S. government and the Chinese government can resolve the trade issues that exist there. I think that will be very helpful to 2019.
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In terms of the outlook for fresh pork, you're right, 2016 and 2017 were very good years in fresh pork. The gap between live hog prices and meat values widened out wider than it had been historically. Those were good years. We have got to, though, lower our cost in our fresh meat plants, and that will allow us to get back to those levels. What we're doing is we're investing in our fresh meat plants. We're going to invest $200 million this year in our fresh meat plants, and that is all capital designed to automate and simplify our fresh meat operations. That spending, by the way, will continue into 2019. We've got several major projects. We have nine fresh meat plants here in the U.S., 10, I guess, including a 10 fresh meat plants.
We're targeting some of our largest plants with that spending, all with a view of reducing our processing cost.
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I think we're in a bad end of a cycle right now, but I do expect that it is just that, it is a cycle between the turning of the cycle and the investments we're making in our fresh pork plants that yes, we will get back to those profitability levels that we've seen the last couple of years eventually. I expect our capital that we've deployed to start to take effect about mid-year in 2019, and should be almost at a full rate by the end of 2019.
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One other factor I should mention that has had an impact on both the fresh meat business and the packaged meats business in 2018 is increased transportation cost. We have had capacity issues in the United States, freight capacity issues that have really driven up our rates, and therefore our overall cost. It's very meaningful for the year. I expect the industry is reacting and adding capacity, and hopefully we'll see a reduction in our freight rates going forward.
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Thank you, Ken.
Okay, before we close the meeting today, I would like to recap on some of the questions about the China business. I think some of the English-speaking investors might have some confusion about the outlook for the packaged meat business. Let me do a short recap here. About 2019, we do expect the overall hog price will be slightly higher than 2018. However, our packaged meat business, our plan is to continue to improve the product mix, which means we are going to roll out more high-end, which also means higher margin products. At the same time, we will also adjust our selling price accordingly to capture the increase of the hog price. Overall speaking, we do expect our profit margin in the packaged meat business will continue to improve given the expectation that the hog price next year will go slightly higher.
For the slaughtering business, we do expect the slaughtering profit per head might slightly come down a little bit in 2019. However, we do believe the packaged meat business in 2019 with the improved profitability, will be able to offset the downside of the slaughtering business in 2019.