Earnings Call: Q2 2023

Aug 23, 2023

Summary

Q2 delivered record revenue and NOK 950m operational EBIT, with stronger VAP and wild catch results. A NOK 1.7bn resource-tax implementation charge drove reported EPS negative; lower harvest guidance and biological challenges temper the outlook.

Good morning and welcome to Lerøy Seafood Group's second quarter presentation 2023. My name is Henning Beltestad. I am CEO of Lerøy Seafood Group, and with me today I have Sjur Malm, which will take you through the financials for this quarter. I will start with this one. I normally talk a lot about our value chain, and our goal is to create the world's most efficient and sustainable value chain for seafood. This is what we do every day, going towards this goal. This value chain is unique both for salmon and trout, and also for whitefish. From roe to final product in the shop, and from our trawlers to final product in the shop or in the restaurants. We set some targets for 2025 and beyond last year, and this is what is going to drive us going forward. We still believe that it is possible to achieve all these goals, and it is in front of us in the everyday operations. When it comes to this quarter, it has been a record revenue and healthy earnings. We had an operational EBIT of NOK 28.7 per kilo, all inclusive, and NOK 25.20 last year. This quarter, we also had a situation where the resource tax was adopted by Norwegian Storting in May 2023. We expect harvest volume of 181,000 tons, lowered compared to earlier guidance because of challenging situation in Lerøy Sjøtroll and also Scottish Sea Farms. It has been a quarter with positive development in VAP, sales and distribution, and much better results than in the same quarter last year. Also a very good development in the whitefish, given lower quota, positive development in this segment. When it comes to the result, we had an operational EBIT of NOK 950 million in second quarter 2023. Lerøy Seafood Group reports in three segments: farming, wild catch, and VAP, sales and distribution. We start with the farming part. It has been a strong biological development in Lerøy Aurora and Lerøy Midt, while challenging in Lerøy Sjøtroll. We had an operational EBIT per kilo in farming of NOK 25.90 compared to NOK 29.30 same quarter last year. Development in second half 2022 impacts through low harvest volume and low average harvest weight in this quarter, and a contract share of 70% in this quarter. We see a significant increase in cost year-on-year, with higher feed cost as a key driver. If we look at the operational EBIT for the farming, we had NOK 767 million, and EBIT per kilo of NOK 25.90 in the quarter. If we go into the different regions or the companies within the segment, we start with the Lerøy Aurora. We see a strong improvement in biological performance continues, but this quarter is impacted by harvesting of relative low volume, but much higher volume than same quarter last year. If we look at the right there, we see that the volume in the quarter is 8,300 tons this year compared to 4,400 tons. We had an operational EBIT per kilo of NOK 33 compared to NOK 20 in 2022. So, improved performance in Lerøy Aurora, and the underlying biological situation is very good, and will continue going forward, delivering good results and also lower cost. If we see Lerøy Midt, there is also a strong biological performance through this quarter. There has been a cost increase quarter-on-quarter, impacted by the challenges that we faced second half last year. But we will see also here, with increasing volume in second half 2023, a significant fall in cost is expected. We expect a harvest volume of 64,000 tons in total, and we harvested close to 10,000 tons compared to 14,000 tons last year, and EBIT per kilo of close to 28 NOK compared to 30 NOK last year, same quarter. Lerøy Sjøtroll Group, good performance and good development for the trout, but somewhat more challenging situation for the salmon. But we have seen improved sea lice situation following a number of initiatives, and there is a good potential for higher net growth second half 2023. And we see the last couple of months that the treatment is down compared to last summer, and also the sea lice levels is definitely much lower than the summer last year. So, a good improvement there. Unfortunately, we had one incident in third quarter, two sites confirmed with ISA, so we had to force harvest with the low average weights. This will have a significant impact on the cost and price realization in second quarter. The best estimate today is a negative result impact of around 200 million NOK in Lerøy Sjøtroll. The harvest volumes in the quarter is 11,400 tons compared to 14,500 tons, and EBIT per kilo of 19.1 NOK. When it comes to Norskott Havbruk or Scottish Sea Farms, there has been a weak second quarter, low harvest volume, and harvesting from biological challenge sites affecting average harvest size, cost, and price achievement. High cost base affected by sites with challenges in second half, and continue into 2023. Incident-based mortality in a quarter of 13.5 million GBP, or 2.1 GBP per kilo. 60% of the volume is sold on contracts. We see still some biological challenges going into Q3, but improvements in the fish size and cost base is seen. We expect that we will have, yeah, much better results going forward, and we also believe that we know the cause of the performance in Scottish Sea Farms and in these sites. There's been challenges with some groups of fish which didn't perform well in Shetland and mainland. But we strongly believe that this will be much better going forward. When it comes to the result, we had an operational EBIT of 144 million NOK, and operational EBIT of close to 23 NOK per kilo, and a harvest volume of 6,300 kilos. When we look at our farming volumes, we see that in Norway, Lerøy Aurora, 47,000 tons, Lerøy Midt, 64,000 tons, and Lerøy Sjøtroll, 57,000 tons. This volume is reduced from last guiding because of the situation with ISA. Scottish Sea Farms is reduced to 27,000 tons, and our share is 13,500 tons, so a total of 181,500 tons. The wild catch has been a very good quarter on basis of lower quota, a strong development in the quarter with catches of alternative species, high volume, and lower prices. We see impact from implementing Lerøy Way in land-based industry. Year-on-year improvement in overall profitability is from improvement in the land-based industry, so that's really positive. We also see cost reductions from the operational view. Lower fuel consumption from using fleet roll for more species. Here we had operational EBIT of 99 million NOK compared to 93 million NOK last year. We see development on prices. We see that there's been a strong increase from third quarter 2021 to what we see today for the cod. We see the last quarters for haddock is going down, and the saithe is pretty stable. If we look at the catch volumes, second quarter, 3,000 tons cod, 2,100 saithe, 2,300 tons haddock, 4,600 shrimps, and others, 11,600. A large part of that is redfish. So, a total of 23,700 tons compared to 18,000 tons last year. So, a very good performance from Lerøy Havfisk. If we look at the VAP, sales and distribution, record revenue in basis of course, higher prices. Significant improvements in profitability year-on-year with operational EBIT of NOK 113 million compared to NOK minus 64 million in second quarter last year. So, we've been handling the fluctuation in prices in a much better way this year. While market demand measured in value remains healthy, the higher price are seen in lower volume and capacity utilization. With seasonality in salmon volume, expectation are for improved capacity utilization and profitability in second half. This shows where we have operation in all central markets in Europe and sale branches in North America and Asia. Then I give the word to Sjur Malm. Yes. Thank you, Henning. This has been a special year for us. It's now about one year since the Norwegian government launched the proposal to implement the resource tax in our industry. That proposal was voted for in the Norwegian Storting 31st of May. That means that this is the quarter where we have to implement the impact from the resource tax. I think the best place to look for more details is in note 10 of our published report. There we will give an insight in more depth than what I will do now on the consequences and our consideration. But shortly, there are two impacts in our P&L. One is the implementation effect, which is a one-off in connection with implementing the new tax regime, and one is the estimate of how large will the running tax cost be under the resource tax. In this report, we have implemented the implementation effect, and we have not given any estimates to running tax rate, and I will return to why. When it comes to the implementation effect, that is NOK 1.7 billion, which is a very, very high number. This tax impact is much related to, it's 100% related to the biomass and the change in taxation on our deferred tax on biomass. If our tax value of the biomass is the same one year from now, that tax will not have to be paid. It will be put forward year-on-year. On that implementation effect, there's been a big debate in Norway. We and the industry believe that there is a massive lack of symmetry between cost and revenue. Basically, in the proposal from the government, they are saying that the cost of our biomass going into 2023 and what we can withdraw from the tax is zero. We do not think that is fair, but that is what we have implemented in our result. Looking then on the key drivers, highlighting key value drivers on the latter lines, we see that we have harvested 10% less salmon. Through the value chain, the margin on that salmon and trout is higher than last year. The key driver for that difference is the better performance in our downstream unit, which Henning already had described. Furthermore, we see the increase in catch volumes of wild catch, and those catch volumes are on lower value species, which impacts then a lower margin. In sum, this gives an operational EBIT of NOK 950 million, which is an improvement compared to the same quarter last year. Looking into the EPS, we see that the implementation effect of NOK 1.7 billion, already commented upon, results in a negative EPS of NOK 2.11. Without the implementation effect, the EPS would be NOK 0.77. Again, please refer to note 10 in the report for more details. Another key factor in this report is the significant revenue growth, which is much helped by higher prices and thus inflation. As Henning showed initially, we have a very long value chain, which means that we own the fish for a very long time, which means also then that the business model require a lot of working capital. That increase in revenue also impacts working capital, and those are basically the key changes when looking at the balance sheet this year compared to same quarter last year. We see biological asset at cost is up NOK 700 million. The key driver there is higher feed cost. We see inventory is up because the value of the goods is higher. Account receivable is up. So there is a significant working capital build in this industry. In this is also a point that in the proposal for resource tax in Norway, it was said that this industry is not capital intensive. From our point of view, this balance sheet shows that there is no substantiality in such claims. This is a very capital-intensive industry. The implementation effect impact the equity ratio, which this quarter is 49%, and net interest-bearing debt around NOK 6 billion. Then showing the change through quarter in net interest-bearing debt, we see the EBITDA of around NOK 1.3 billion. Change in working capital is derived from the higher revenue and higher prices of our goods, and higher feed cost. CapEx, it is around 50%, which is related to our acquisition of the operating company at, in Lerøy Skretting harvesting facility, and the 50% which is related to more running CapEx. We paid NOK 2.5 in dividend this quarter, and you can see the impact of net finance and taxes paid. In sum, our net interest-bearing debt is close to NOK 6 billion end quarter. Then some comments on why have we not given an estimate on running tax or resource tax as share of profits so far this year. And obviously, we would like to do that, but it is also important for us that when we give an estimate, this needs to be a valid estimate. At current time, we believe it is too early to give such estimate. What is shown on the picture to the right is part of the value chain, which Henning started on. The black box is showing what is the farming segment. The red box is the part of the farming segment which is seeing an increase in taxation by 25% to 47%. Historically, we have always measured profitability in the farming segment as a whole. We have moved the goods and services through the value chain at cost, and we have not focused too much on what is the value creation on each step. The work we are currently doing is to update all internal agreements to create a full transfer pricing documentation and be able to measure the correct value creation at each step in the value chain. Before we finalize that work, and the challenge here is that for many of the goods and services, there is no open market, so there is a lot of work in the documentation. That means that at current point in time, we do not have a valid estimate on the tax rate in the farming segment, because we need to calculate then the value creation at each step. We will get back to that as soon as we believe we have a valid and good estimate. Then there is a debate, maybe particularly in Norway, related to the contributions from this industry. This slide is from 2022 numbers. It is then before any resource tax. It shows a map of Norway. The red dots are where we are operating today, and the black dots are suppliers where we have made acquisition of goods or services. Obviously, the impact when it comes to ripple effect from Lerøy buying goods and services of NOK 20 billion from 5,000 suppliers all over Norway, that is substantial ripple effects. The core of the discussion on resource tax is obviously it does not make sense to withdraw investment fund from the coastal industries and transfer them into the central government. We fear that the long-term consequences would be negative when it comes to value creation. We also believe it is important to highlight that already we are paying NOK 2 billion in fees and taxes in 2022, and that we have more than 3,500 employees all over the Norwegian coastline. Second point is, how does this industry fare in the global comparison? Particularly in Norway, we get some negative news on our environmental impact, and obviously, we work very hard to reduce it, and we believe we can improve. But it is important for us also to highlight that in the global comparison, this industry acquires a very low amount of water, very low amount of energy, and that the GHG emissions are very low. In such international comparison like Coller FAIRR, you will find Lerøy rated as one of the world's three most sustainable protein producers, and you will find the industry in general on top of that list. Knowing that around one-third of global GHG emissions comes from the food value chain, we strongly believe that we are part of the solution, and we hope that Norwegian politicians will start making framework conditions for this industry to continue its growth. We can significantly impact the GHG impact from food production. We have a good starting point, but we are also working to improve. It is positive for us that in PwC's annual review of large Norwegian companies, Lerøy was one of 9 companies en route to reach the Paris Agreement. That is the second year in a row we are on that list, and we are proud of that. It shows we are working very hard to reduce our footprint. Henning, I give the word back to you. I will take you through the outlook. We start with the supply side. Now we see for 2023, globally there will be zero growth. If we look at last year, there was minus 1.2% growth. For the last 2 years, there has not been any growth at all. The expectations for 2024 is 4.2%. That is still early to say. It depends how the biology will be the second half of this year. If we look at the consumption, year to date June, we see that the EU is going down by 7%. A lot of the business in the EU is connected to retail, and the fluctuation in prices that we are seeing is making it difficult to make stability for the retail segment. If we look at other markets, it is up by 3%, and that is ASEAN markets in general. They are more flexible in taking out the fluctuation in prices. For the first half, with extremely high prices, they are actually increasing. So, a very positive trend in that market. The U.S. is stable. Also, a strong performance with extremely high prices for 2023 so far. I talk about the fluctuations, and here we see the last couple of years, the prices has fluctuated from under 60 NOK to up towards 130 NOK. So, of course, it is hard for our customers, our partners, to scale up business when we have these kind of fluctuations. So, it has been challenging for our customers, for our own operations. I have to say that this year we have been much better in handling this fluctuation than last year, where we had a negative result in second quarter. For the outlook, for farming, like we said, proposed resource tax adds a lot of uncertainty. We expect 181,000 tons of salmon and trout, a contract share of 15%. I will come back to the last one there that is about technology development in our farming site. Wild catch demand development varies across the species. Positive development in land-based industry. Quota advice for 2024 is cod down 20%, haddock down 25%, and the saithe is up 25%. For the sales and distribution, we expect improved earnings in 2023 versus 2022, with further potential in years to come. Resource tax, also here, adds uncertainty and challenges to value-added processing activity, in particular in Norway. Weakening demand in some market segments, but overall, a very good demand for seafood remains strong. I will talk a little bit about investments, the green investments in new technology, protecting the salmon from sea lice. Sea lice is one of the biggest biological and cost challenge facing Norwegian aquaculture, but also in other regions. The increasing lice pressure is a main challenge, reducing fish welfare, drives up production cost, and reduce growth. Reaching our goal for 2025 require us to find solutions to reduce the number of sea lice treatments. If you look at Norway on the right side, we see there has been a, yeah, I would say a negative development in reported lice treatments in Norway. The highest year is 2022. We need to find a way to solve this situation. The technology team in Lerøy have over years worked with new technologies, looking at alternatives, more than 70 alternatives, and we have come up with some solution for our operations to solve the most challenging sites. I will show you some of them. Like I said, we are investing in new production technology to protect against sea lice. We had submerged the cage, sinking the containment for our exposed and our deep sites down to 30 meter. That's one example. We have semi-closed containment, and we have different solutions for that that we are started to implement at the moment. This is the two ways of doing it. We have the submerged cages, and we have the semi-closed containments. Within this year, we will have 51 units of submerged cage in five sites within end of this year. We started the implementation in second quarter 2023. So far, it shows really good results. From the semi-closed, we have chosen three different semi-closed solutions and started to implement that also on the locations. We will have 13 units at four sites beginning of, yeah, in first quarter 2024. 20% of our salmon stock to be protected, that's our target, to be protected by first quarter 2024. We really means that this is the way to go, and this is a good solution for us to produce near to the coast and in our fjords in a sustainable way. We need to act if we're going to achieve our targets for 2025, which is 205,000 ton harvest volume, 93% superior quality, 4.5 average harvest weight, and 1.19 economic feed conversion rate, and a cost reduction of close to 5 NOK. We will show you a video of these kind of technologies.