Greetings and welcome to the Saputo Inc. Fiscal 2020 second quarter results conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session. At that time, if you have a question, please press the one followed by the four on your telephone. If at any time during the conference you need to reach an operator, please press star zero. As a reminder, this conference is being recorded on Thursday, November 7th, 2019. I would now like to turn the conference over to Lino Saputo. Please go ahead, sir.
Thank you, Frank.
Good afternoon, everyone, and thank you for joining us today. A press release detailing our 2020 second-quarter results was issued earlier today and is also available as we speak on our website at www.saputo.com. This call is being recorded and will be posted on our website for future reference. I'd like to specify that our listeners on the phone and on the internet, as well as journalists, are on a listen-only mode. Members of the media are invited to ask their questions by phone after this call. Before we proceed, please be reminded that some of the statements provided during this call are forward-looking. Such statements are based on assumptions that are subject to risks and uncertainties. Refer to our cautionary statements regarding forward-looking information in our annual report and our releases and filings. Please treat any forward-looking information with caution, as our actual results could differ materially.
We do not accept any obligation to update this information except as required under securities legislation. Lino A. Saputo Jr., our Chair of the Board and Chief Executive Officer, will begin this conference by providing a brief overview of key highlights relating to the second quarter of fiscal 2020, after which he, along with Maxime Therrien, our Chief Financial Officer, and Kai Bockmann, President and Chief Operating Officer of Saputo Inc. and the International sector, will proceed to answer your questions.
Thank you, Sandy, and good afternoon to you all. Our fiscal 2020 second-quarter results were released this morning, and I'm pleased to see we're making great progress despite facing persistent headwinds. These results reflect the groundwork we've laid through our recent acquisitions, and I'm delighted with our evolution. Consolidated revenues increased by 7.2%, and adjusted EBITDA grew by 24% to CAD 394.4 million. These increases were driven by many factors, including the addition of our Europe sector, higher international selling prices of cheese and dairy ingredients, higher domestic selling prices in Canada and in the international sector, favorable market conditions in the U.S., improved operational efficiencies, and lower warehousing and logistics costs. However, our results were impacted by lower sales volumes in the fluid milk category in Canada and reduced raw milk availability in Australia.
Accordingly, the Canada Sector will continue to place efforts on securing profitable sales volumes to counterbalance competitive market conditions, which, by the way, appears to be waning in intensity, further concentrate on specialty and value-added products, and leverage consumer and customer loyalty. Despite current domestic commodity market conditions in the U.S., we're now experiencing a better equilibrium between supply and demand of dairy products. This sector will continue to focus on operational efficiencies and cost controls to mitigate the impact of dairy commodity market fluctuations, competitive market conditions, and high warehousing and logistics costs. The International Sector, which includes both Australia and Argentina, will keep optimizing its product mix and customer portfolio in all markets while emphasizing innovation. In Australia, we continue to feel the impact of decreased milk production in various parts of the country.
As we advance in fiscal 2020, we expect continued competition in the sourcing of raw milk to persist, putting pressure on margins. To help compensate, our Saputo Dairy Australia will employ alternate measures to assist in increasing the amount of milk being processed in our plants. We intend to remain flexible and agile, leveraging our entire Australian platform to produce the right products in the right facilities and in the right quantities. Last week, we concluded the acquisition of the specialty cheese business of Lion Dairy and Drinks, which produces markets and distributes a variety of specialty cheeses under well-known brands such as South Cape, Tasmanian Heritage, Mersey Valley, and King Island Dairy. We're thrilled to welcome 400 new colleagues to our team in Australia, as well as add two manufacturing facilities in Burnie and King Island, both in Tasmania, to our portfolio.
In the U.K., we remain committed to aligning processes and systems while sharing best practices. During the quarter, we completed a public offering and a concurrent private placement, raising gross proceeds of approximately CAD 659 million. This equity offering is part of our company's capital management strategy and aims to delever our balance sheet as we target a ratio of approximately two times net debt to adjusted EBITDA on a long-term basis. We strive to maintain a well-balanced capital structure, keeping shareholder value creation at the forefront of our strategy. As leaders in the dairy industry, we will pursue our growth strategy with a disciplined and responsible approach, an approach that also embeds the Saputo Promise in everything we do.For us, pursuing growth as a global dairy processor includes building a healthier future for our employees, consumers, customers, and those living in the communities where we operate.
For the remainder of fiscal 2020, our strategy remains clear. We will do all we can to mitigate downward market pressures, as well as focus on operational efficiencies in all our business segments. With a strong management structure and a devoted team of talented and driven employees, we will continue to push our business forward. I thank all of them for their passion and their dedication. On that note, we will now proceed to answer your questions. Frank?
Thank you. If you would like to register a question, please press the one followed by the four on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the one followed by the three. One moment please for the first question. Our first question comes from Irene Nattel with RBC Capital Markets. Please proceed.
Thanks, good afternoon, everyone. Lino, I think on the last call I said that you sounded less cautious and certainly these numbers bear that out. As we move through the rest of the year, could you just talk a little bit about, particularly in the U.S. and in Canada, what has shifted other than the sort of the cheese pricing and how you think the situation evolves as we move through calendar 2020?
Yes. Thank you very much for that question, Irene. When you think about the overall market, there's a better balance between supply and demand. Of course, that has an impact on our selling prices of dairy goods. Perhaps less relevant here in Canada, but more relevant for the U.S. Let me talk about these individually. In the U.S., with the rise of the block price that has created a great environment for us to be able to mitigate some of the headwinds we have coming from, say, the byproducts. That has been a positive catalyst for us at achieving the results in our cheese business in this quarter here. As well, in the U.S. platform, we have the SAP rollout program out of the SDF platform.
Now our team in SDF have gone back to operating the business the way they know how to operate the business. Our results, I would say, in SDF are favorable. If I can say this perhaps in a very simpler term, they seem to have gotten their mojo back. We're delighted with the progress that the U.S. team has gained over the course of these last quarters. I'm delighted about their proactivity in taking the right decision at the right time, not getting overwhelmed by market conditions, not by being overwhelmed by some of the challenges that we throw at them, just like the SAP rollout and conversion, and just try to find solutions every single day while we're operating the business. I'm very proud of the progress that the U.S. team has made. SDF is back on track.
USA Cheese has ridden the wave of the rise in the block price and still are feeling the effect of not so much value in the byproducts. They're finding other ways to create value in that platform. On the Canadian front, a little bit different story. Of course, as you know, with the milk supply management system, supply demand is not the issue. What the issue was in Canada was the irresponsible behavior of our competitors when it comes to pricing products on the market. Perhaps you may have seen some changes within the structure of our competitors who I think realized that that is not a winning model. I'm more optimistic going into the next quarters than I was coming out of the previous quarters. In addition to that, though, I have to compliment our Canadian team for rightsizing the business.
We lost a chunk of volume when RFPs came out at unreasonable prices. We were disciplined enough to draw the line and tell our customers that at those prices we can no longer service them. They have taken good immediate action to rightsize the business. That means, unfortunately, sometimes some layoffs in certain key areas, and some realignment in our manufacturing footprint. As it turned out, our competitor in some markets weren't able to service as effectively as they had promised. The retailers come back to us, and we're prepared to take them back under our terms and our conditions. That makes us that much more efficient, and that makes us that much more effective.
Again, with the steadfast leadership we have in all divisions in North America, whether it would be on the SDF side, on the Cheese USA side, and in Canada, we are showing the results that we're showing this quarter. I would say unless there would be other irresponsible behavior or perhaps market collapse, I expect this to continue moving forward.
That's very helpful, thanks. Boys definitely had their flag when we were down in the U.S. One other question, if I might. Just on the international side, there are so many moving pieces in that segment with the sharply lower milk intake and the lower peso and lower whey demand. There's just an awful lot going on, Lino. If you wouldn't mind just taking a moment and walking us through the puts or actually mostly takes in that segment this quarter and again, how you see that sort of playing through.
If I look at just those different markets individually, if we look at Australia as an example, yes, the milk intake is down. There too, we've got some very agile operators in the field that know how to take the tough decision in a tough environment. I did mention in previous calls that even though our patron-based milk is declining because of the decline in production in the country, we're finding alternate ways to get volume to our plants. Essentially for us, it's important to get as much volume through our plants as possible to drive efficiency. We're looking at either co-packing for others, which by the way, we've been very successful at bringing in milk from some of our competitors where we are co-packing for them, and we're also looking at third-party milk, so buying milk from brokers.
Again, on top of all of that, we're trying to capture the low-hanging fruit from our newly acquired Murray Goulburn platform in Saputo Dairy Australia. There still is quite a bit of runway for us to be able to achieve some of those efficiencies, despite the fact that we don't have as much milk as we would have originally anticipated. Again, this is proactive, agile management. This is what we're all about. Many times when these tough situations occur, we find opportunity in them. I find our management team is very good at finding those opportunities. The same could be said for our Argentinian management team. We've got a very experienced management team in place, a team that we've known since 2003 from when we acquired the business, still the same people operating day-to-day. They know how to navigate through the political uncertainty.
They know how to navigate through the environmental, political uncertainty. We rely on their guidance to take the right decision every single day. As a management team, all we do is we provide them the support to be able to take tough decisions when tough decisions are required. Perhaps maybe I can ask Kai to provide a bit more color within either of those platforms.
Those two platforms offer a unique opportunity to really have a lot of flexibility in terms of where the raw material goes. Those would be the most flexible platforms of all of our divisions. If you look at Australia, we have a nutritionals business, we have an ingredients business, we have a fluid milk business, cheese business, and now a specialty cheese business. We have the ability to ensure that we generate the highest return per liter of milk, maximizing the yield per liter of milk. The same goes for Argentina as well. We do have the leaders in terms of that domestic market as well as the export market. A lot of our competitors in Argentina, for instance, don't have that same capability to have the export platform offer diversification opportunities.
By having that flexibility and having a laser-like focus around generating the highest variable rate of return per liter of milk, that allows us to be successful in a volatile environment.
That's great. Thank you.
Thank you, Irene.
Our next question comes from Peter Sklar with BMO Capital Markets. Please proceed.
Lino, I think you pretty well covered it by going around the world. I just had one question. In your comments in terms of your outlook, you're talking about the ingredients market, the outlook being volatile as opposed to having a definitive view as to whether prices are going to firm or fall off. I'm just wondering what your thinking is on the ingredients market and what steps Saputo is taking to improve your performance there. Like you talked about on previous calls, how certain things like MPC80 have become commoditized. Just wondering what steps you're taking.
Peter, as I also indicated in previous calls, we like to look at different categories of products that are value creations. We did that, and I used the example back in the last conference call, back in 2004 or 2005 when everyone was making whey powder, we made an acquisition, and we made some investments to get into highly specialized whey protein concentrates. We had a really good run of that probably for a good 15 years. Of course, a lot of our competitors are looking at our playbook and saying, "Well, we can be in that category as well." As they're putting on new capacity in their plants, they're getting into those commoditized, those products that were once value-added and making it commoditized.
Now with our team of researchers, whether they would be within the corporate structure or in the divisional structure, we're looking at what's the next generational product that we can make from our byproducts and create further value for ourselves. We're always in this mode of looking at perhaps creating more value with the same raw material that we currently have. We can do that similar to what we did in 2004 or 2005 with WPC through the acquisition of Land O'Lakes. We can do it through an acquisition or we can develop it in-house. We're looking at all different kinds of possibilities. I would not exclude an acquisition. I would not exclude CapEx allocation to products that are going to generate a higher value for those raw materials that we currently have in our control.
You're talking about a process, but is there anything on the near-term horizon that could evolve in your ingredients business?
Yes, there is. For the sake of competitive reasons, I don't want to get into too many of them. Our team is quite active on that front.
Okay, thanks very much.
Understand, Peter. When you're thinking the near term, the technology does exist. The ability for us to get into that does exist, but you do understand as well, if it would require equipment and installation, many times it would be 18-24 months before we buy the equipment, get it installed, and get the plant debugged. Yes, the technology is imminent. The installation and execution might take a little bit more time.
Okay, I understand. Thank you.
Our next question comes from Vishal Shreedhar with National Bank Financial. Please proceed.
Hi, thanks for taking my questions. In Canada, I know you indicated that things seem to be looking up a little bit. Just wondering, as you look back through history on the volatility of that competitive level, has that period that we've just gone through been an outlier or does this volatility kind of come and go with different regimes and different pressures on the various competitors?
Yeah, that's a very good point, Vishal. I think it does come with different regimes. Let me say this. It is unfortunate, really unfortunate, when you have a player that comes into the dairy industry that is not from the dairy industry, that doesn't understand that the cost of raw material represents 85% of your cost of goods, and it takes them two or three or four years to figure that out. In the meantime, they take value out of the space, and then they're gone and we're still here. Yes, the marketplace is shifting. We see that some of our competitors have announced that they're going to be focusing now more on profitability than volume. That's what we've been doing since 1954. That's who we are. That's in our DNA. We haven't changed our outlook, but we have to understand that, yes, unfortunately, sometimes history repeats itself.
When we got into the fluid milk business back in 2001, when we acquired Dairyland, margins were minuscule in fluid milk. We brought some discipline to the market. We brought some, I think, a lot of responsibility back to market. That's where margins started to get a little bit better in fluid milk because we weren't going after these big contracts just to get volume through our plants. Quite frankly, we were getting out of some commitments with customers if we weren't making the right returns. That brought a lot of discipline in the market, and that discipline has been there from 2002 all the way through just about two or three years ago to 2016. All of a sudden, somebody wants to go after market share at all costs. Now all of a sudden, we're going backwards, back to the pre-2001 days.
I'm hoping that the industry has learned its lesson. I'm hoping that the players that are going to be here are thinking about a long-term perspective on creating value for dairy. It's in their best interest, it's in the farmer's best interest, it's in the consumer's best interest that we create value as opposed to beating each other over the head with a two-by-four and expecting to survive. I'd like to say that history will not repeat itself. I think there is a little bit of peace in the valley for now. Either way, Vishal, we are going to survive. We will find ways to find solutions, to rightsize our business and walk away from volume if we have to. I'm just hoping that everyone in the industry will have the same discipline.
Just switching topics here on capital allocation. You noted a desire to take down leverage to about 2 times, which has been indicated in the past. On the call, similarly, you indicated the possibility of strategic acquisitions for certain categories, which I think is also consistent with your prior messaging. Just to be clear here, are share repurchases out of the picture until you get to your leverage target?
Well, for the moment, a share repurchase is not in the scope, it's not in the plan. We tend to use the cash more in terms of the deleveraging perspective and continue to queue our CapEx projects rather than to buy back share that we issued some actually a couple of months ago. It's not in the radar for the next future.
Okay. Thank you for your color.
Our next question comes from Michael Van Aelst with TD Securities. Please proceed.
Thank you. The comments, I'm trying to, I guess, understand your outlook statement because the comments sound more positive in general, but your net guidance comment, your bottom line guidance comment for slight improvement in that consolidated EBITDA is unchanged. What is it that's holding you back from getting more positive on that kind of bottom line outlook?
I'm glad you asked the question, Mike, because I'd like to clarify that. Look, from a day-to-day perspective, operations, I think we have the right people in the right place and we're taking the right decisions. The headwinds that we're thinking about that still make us a little bit reserved would be things like trade wars. There is so much volatility every single day. You see it on the stock market. We feel it in our order patterns. Trade wars don't create any sense of comfort for anyone, and they don't provide you an opportunity to think longer term, not for us, but for some of our customers and some of the buyers of the products in the world market. The trade wars are one element that we don't control.
When you think about unsettled economies, possibility of recession, some people believe that the recession is right around the corner. Others think that it's a long way out. We don't know. We don't control that. I'm also thinking about now that there's a discipline in the market in terms of supply and demand, production is balanced and sales continue to grow. That's a very good dynamic for the industry. There too, if I look back at history, any time the dairy suppliers start to make money with raw material, the first thing they do is they put more capacity in the system, and if they put more capacity that exceeds consumption, then we get back to an overcapacity issue. We don't control that. We can try to communicate it as much as we can to the dairy farmers, but we don't control that.
We still need to be cautious even though we feel good about where we fit. You look at our balance sheet, you look at the acquisitions that we made over the course of the last two years. Over the course of the last two years of turmoil, we have grown our platform with value assets. We feel extremely good about that. That's our optimism. There's so much in the industry that we don't control that creates short-term pain that forces us to remain cautious.
If nothing changed on the trade front, like the tariff stayed in place and all that, nothing changes from where it is today, the economy kind of stays roughly the way it is today, there's not a huge change in the supply, demand and balance, you would be more positive.
I would be extremely more positive. I would feel very good about where we sit. Again, we don't control those elements. Those are things that are out of our control. Like I said, Michael, we can respond to it effectively, but sometimes that response will take some investment. Sometimes that response will take some time. We know for the medium long term, we're going to find the right solution. It's the short term that we have to be cautious about.
Okay. The only area where I found it a little bit more confusing on your outlook statement was the international side, because you kind of talk like the outlook makes it sound like the second half of the fiscal year is going to get tougher in Australia. Is that the one area that you might see it get worse before it gets better?
Well, there could be a little bit of volatility in Argentina, first and foremost, after the elections. We don't know what way the government's going to go with export taxes as an example, and what that's going to mean to inflation and what that's going to mean to disposable income for the domestic market. Those are all unknown. It's not like we haven't been there before. We've been there, and I'm sure we're going to adjust. How long will it take us to adjust? On the Australian side, we've got a lot of great ideas and a lot of great plans that we're going to put in place with the current milk base that we have.
If the milk continues to decline, we don't think it will, but there too, the climate isn't changing that much, and there might be more deterioration of milk production in Australia that is beyond our control. Of course, with the deterioration of the amount of milk that's available, what will our competitors do to buy that milk? How much will they pay for it? Raw material, as I indicated, is 85% of cost of goods sold. That's something we need to be mindful of. That's where our caution comes in. I might ask Kai to give you a little bit of color on that as well.
I just wanted to add also, Michael, that when we enter our third quarter, we're entering the low milk year, the low milk production cycle when you're looking at the Southern Hemisphere. If you're looking at Australia, where they've lost about fourteen and a half liters of milk over the last five years in terms of total production, 1.1 of that is in Victoria, where we primarily operate in. We're going to be seeing a difficult environment from a milk production standpoint with the weather impacts and the current situation. There will be some headwinds as we go into the third quarter when it comes from an Australian milk production standpoint.
Okay. Just finally, in Argentina, the hyperinflation seems to really be helping on the profitability of your export sales. Would you say that your Argentinian profit margins are above average at this point?
Well, it all depends what is the average for a platform like Argentina. If you compare to, say, the prior year for the Q2 results, we're within the zone. The milk cost turns around $0.27 to the U.S. is comparable, but slightly above last year's milk cost. Last year was around the $0.20 mark for Q2. We're definitely better than, say, the average since we've been having the business, but comparable to the prior year.
All right. Thank you.
Mr. Saputo, there are no further questions at this time. Please continue with your presentation or closing remarks.
We thank you for taking part in this conference call. We hope you'll join us for the presentation of our fiscal 2020 third quarter results on February 6th. Have a nice day.
That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line. Have a great day.