Adecoagro S.A. (AGRO) Q2 2016 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen and thank you for waiting. At this time we would like to welcome everyone to Adecoagro's Second Quarter 2016 Results Conference Call. Today, with us we have Mr. Mariano Bosch, CEO; Mr. Charlie Boero Hughes, CFO; and Mr. Hernan Walker, Investor Relations Manager. We would like to inform you that this event is being recorded and all participants will be in listen-only mode during the Company's presentation. After the Company's remarks are completed, there will be a question-and-answer section. At that time, further instructions will be given. [Operator Instructions] Before proceeding, let me mention that forward-looking statements are based on the beliefs and assumptions of Adecoagro's management and on information currently available to the Company. They involve risks, uncertainties and assumptions, because they relate to future events and therefore depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of Adecoagro and could cause results to differ materially from those expressed in such forward-looking statements. Now, I'll turn the conference over to Mr. Mariano Bosch, CEO. Mr. Bosch, you may begin your conference.

Good morning and thank you for joining Adecoagro 2016 second quarter results conference. As you may have seen in our release, we reported the strong results in all of our businesses. This was a combination of a number of factors of which our daily work and efforts to maintain a low cost of production constitute the most important one. As we have always remarked, being the low cost producer is the only way to run a profitable business in an industry where we cannot control variables such as price and weather. Basically, our formula to control and reduce cost consists of, one, enhancing both industrial and agricultural efficiencies and two, increasing productivity. In our earnings release, we are showing productivity increases in all of our businesses. For example, in Argentina, we are reporting crop yields inline with the previous season which were record harvest despite the abundant rainfall that we suffered. Our milking cows continue increasing productivity, reaching more than 35 liters per day per cow, the highest in the industry. In our sugar ethanol and energy business, TRS per hectare increased quarter-over-quarter reaching 13.3 tons per hectare. This industrial and agricultural investments dilute our fixed cost and are reflected in the results of each quarter. Specifically, in the sugar ethanol and energy business, we have reported that our industrial and agricultural costs measures per ton of sugarcane crushed and per ton of TRS have decreased by 12% and 9% respectively. We are aware that there are still many things that can be improved and consumed to continue reducing our cost of production. While many of these things, I am excited about our prospects. We are really proud on the quality of the operational and management team which we have developed in each business and are confident that we will reach our operational and return targets. At the same time, we continue looking for accretive growth opportunities in each of our business lines to continue generating value and effective returns for all of our shareholders. Now, I would let Charlie walk you through the numbers of the quarter.

Thank you, Mariano. Good morning, everyone. Let’s start on page 4 where I would like to comment on the water conditions in our cluster in Mato Grosso do Sul. As you may see on the chart, the recent excess rainfall during May which caused logistic and operational disruptions as we have explained the fact and the soil humid we have to stop harvesting activities to avoid the damaging of soil with heavy harvesters, tractors and trailers. Ranged in May and the first half of June were not only a part of the historical average, but also highly dispersed resulting in significant operational downtime. Let’s move to Page 5. As a result of the excess rains, we had 13% net effective milling time in the quarter. At the same time, our milling volumes a day increased by 6% as a result of the ramp up of Ivinhema mill and higher operational efficiencies across harvesting, logistics and milling operations. As a result of these two factors, we were able to crush a total of 2.7 million tons in the second quarter of 2016, 8% below last year. On a year-to-date basis, however, due to the early commencement of the harvest as part of the continuous harvest model that we have implemented since the beginning of the year sugarcane crushing has increased by 24% year-over-year. Finally, I would also like to highlight that in July and first week of August, rains have normalized and returned to historical average. Therefore, we have been able to accelerate the pace of billing and have compensated most of the delay generated in the second quarter. Please turn to Page 6, where I would like to highlight our fuel, agricultural, productivity metrics. We remain fully focused on agricultural productivity since we understand that is the main driver for becoming the low cost producer. Over 70% of total production costs are related to sugarcane production of this yield. As a result, yields per hectare during the quarter has reached 111 tons, 11% higher than last year, while TRS per ton has increased by 7% as a result of the excess rains. Finally, TRS per hectare remains 3% higher than last year. Let’s move to Slide 7. Production during the second quarter has been negatively impacted by the decrease in sugarcane crushing. As a result, sugar and ethanol production fell by 10% and 12% respectively resulting in an 11% decrease in TRS equivalent produced. Energy exports only dropped by 6% since we begun burning our stockpile of bagasse carried since the first quarter as market prices began increasing. As explained earlier, this is only a delay in production which we expect to offset during the third quarter. Let’s now move to Slide 8. Despite lower milling and production volumes, we have been able to reduce our operational costs. As you may seen the table, unitary production costs measured in terms of sugarcane crushed and in terms of TRS produced decreased by 12.4% and 8.8% respectively in the second quarter. Furthermore, cost dilution was achieved at both the industrial and agricultural sides of the business. This was been the result of an ongoing process of efficiency enhancement and fine tuning across the entire production process seeking to become the low cost producer of sugar and ethanol in Brazil. The depreciation of the Brazilian real also contributed to the dollar cost dilution even that most of our cost of production are measured in local currency. On a year-to-date basis, unitary production costs have also decreased by 20.4% and 15.4% respectively. Now, let’s please turn to Slide 9 where I would like to discuss sales. Net sales during the quarter were $86.3 million, slightly higher year-over-year. The dynamics of sales are mainly driven by present and expected realizing prices. During the second quarter of 2016, sugar prices were much higher than ethanol prices measured at sugar currently. This explains why production was more skewed towards sugar production during the quarter and sales volume increased by 20% compared to the same period of last year. In the case of ethanol, sales volumes decreased by 22% compared to last year resulting in an 18% decrease in sales. This is explained by our ethanol carry strategy due to market seasonality. Ethanol prices are highly seasonal. Prices are usually very weak during harvest time as all mills are crushing and supplying ethanol to the market. As we get close to the end of the harvest, ethanol volumes start to decrease pushing prices up. Prices reached seasonal highs during the first quarter and mills stop milling generating a shortage of supply. We are able to benefit from this seasonality curve as a result of our surge capacity and our strong balance sheet. During the year, the second quarter, we decided to minimize ethanol sales and start to fill up our tanks in order to capture higher prices towards the end of the year and enhance our margins. In the case of energy, despite a 90% increase in volumes sold, sales were 47% lower than last year. This is explained by lower cogen prices as a result of normalized hydropower supply and lower energy demand. Finally, to conclude with the sugar ethanol and energy business, I would like to focus on Slide 10. Here, we can see the overall financial performance of the sugar and ethanol and energy business. Adjusted EBITDA in the second quarter 2016 reached 50.6%, 3% higher than the second quarter of 2015. Adjusted EBITDA margin grew from 57% in the second quarter of 2016, to 59% in the current quarter. Despite an 8% reduction in sugarcane crushing due to excess rains, lower ethanol sales as a result of the implementation of an ethanol carry strategy to capture higher prices towards the end of the season and a 13.1 million mark-to-market low from our sugar hedge position, we were able to increase margins. The main factor contributing to enhance this financial performance during the quarter were, a 12% reduction in unitary production cost as a result of our focus on operational efficiencies and the devaluation of the Brazilian real and higher sugar prices and sugarcane builds resulted in a $17.7 million increase in changes in fair value of unharvested sugarcane offsetting the negative mark-to-market result of our sugar hedge position. On a cumulative basis, adjusted EBITDA for the first six months of 2016 grew by 41% reaching $72.7 million. Adjusted EBITDA margin expanded to 47%. These results are primarily explained by a 24% increase in crushing volumes, coupled with a 17% increase in TRS sold. As a result of the early start of the harvest due to the implementation of the continuous harvest model. Enhanced agricultural efficiencies and the devaluation resulting in a 20% dilution of unitary production cost and higher sugar prices and yields resulted in a $27.7 million year-over-year gains from the fair value of unharvested sugar. Results were partially offset by a $12.3 million loss generated by the mark-to-market of our sugar hedge position compared to a $13.9 million gain generated in the first six months of 2015. We will now turn to Slide 12 of the presentation, where I would like to give an update on the harvest of our most relevant crops. As you can see in the top-left chart, as of July 2016, the harvest of soybean’s crop was fully completed. Average yields were, overall, 11% lower than previous harvest season. Productivity was highly variable by country and by region as a result of weather volatility caused by El Nino. I would like analyze performance by country. In Argentina, the northern region was affected by excess rains during May. Yields in that region decreased 13.5% compared to last year, reaching 2.4 times per hectare. In the Humid Pampas, the timing and intensity of rainfalls were optimum allowing the crop to fully develop. As a result, yields reached 3.6 tons per hectare, in line with the previous harvest season which has been record crop. Overall, yields in Argentina decreased by 5.9% to 3.2 times per hectare, but remain above the historical average. In the case of Uruguay, the region was affected by the strong El Nino which took place during the first half of the year. This resulted in excess rainfall and floods which negatively yields and quality of the crop. Yields were 25% below the previous season. In western Bahia, Brazil, contrary to what happened in Argentina and in Uruguay, El Nino resulted in a severe drought. As a result, yields were 20% below year-over-year. The harvest of Soybean 2nd crop was also completed. Average yields reached 2.4 times per hectare in line with the previous harvest year which is a record crop. High productivity was driven by executing and efficient planting schedule. In the case of corn crop, as of the end of July, 54% of the total planted area was harvested. The average yield obtained so far were at 6.2 tons per hectare in line with the previous season. As you may see in the pie chart, in order to diversify our crop risk and water requirements, approximately 24% of the corn was planted early in September, whereas the remaining 76% was planted during November and December. The harvest is expected to be completed during – and we expect corn yields to remain in line with current levels. Lastly, in the bottom-right box, you can observe that at the end of July, the harvest of sunflower was completed producing over 15.5 thousand tons. The average yield was 1.6 tons per hectare, slightly below the previous harvest year. Let’s move to Page 13 where I would like to walk you through the financial performance of our farming business. As you may see in the chart, on a quarterly basis, adjusted EBIT for the farming business was 5.1 million, 85% higher year-over-year. This increase is mainly explained by the crops business. Adjusted EBITDA for crops reached $3.4 million growing 389% higher year-over-year. This increase is mainly explained by the crops business. Adjusted EBITDA for crops reached $3.4 million growing 389% year-over-year. The increase is primarily explained by a $23.1 million increase in crops margins resulting from higher corn and soy prices in the local markets, as a result of the elimination of export taxes and quotas. Lower production cost as a result of the depreciation of the Argentine Peso in real terms coupled with lower input prices of seeds, fertilizers and agrochemicals. Results were partially offset by a $20.1 million loss derived from the negative mark-to-market of our commodity hedge position. Regarding the rice business, due to a seasonality and growth cycle of the rice crop, most of the margin generated in the 2015 and 2016 harvest was recognized in the first quarter from 2016 when the crop was harvested. Adjusted EBITDA generation during the rest of the year is driven by sales of processed rice and byproducts, net of selling expenses and overhead costs. Adjusted EBITDA grew 408% compared with last year, driven by higher sales volume. In the case of the dairy business, our operational performance during the quarter was very good and we continue to see improvements in productivity as we consolidated the Free-Stall facility. Milk production volumes reached 21.6 million liters marking a 3% increase year-over-year driven by a 2.6% increase in our dairy cow herd. The gains on GDP were offset by lower selling prices resulting in a 39% decrease in adjusted EBIT. On Page 15, I would like to comment on commodity hedging. First of all, as a reminder, I would like to make a few comments regarding the rational and strategy of our hedging program. First, Adecoagro has renowned commodities. As we own the producing assets, both land and the industrial facilities. Secondly, our margins and cash flows are affected by the volatile price environment inherent to agricultural commodities. The objective of our hedging strategy is to mitigate short-term price volatility allowing to lock-in margins and securing a more predictable and stable cash flow to face capital obligations and working capital requirements over the upcoming six to 12 months. As you may see on the chart on the left, we have entered into hedge positions for our soybean, corn and sugar production related to the corn harvest, and have also started hedging next year’s production. Our second chart of the commodity rising experienced during the second quarter as yo9u may see on the top chart the mark-to-market of our hedging position as of June 30 of 2016 resulted in $34.1 million low, which is mostly unrealized. However, since June 30, commodity prices have decreased devoting most of the loss in the quarter. In addition, I would like to highlight that biological assets and grain inventories in our income statement are also measured at fair value. Therefore, gains or losses from our hedge position are naturally offset by changes in fair value of biological assets on the mark-to-market of inventory. In the case of current crop hedge, the offset you can easily recognize in the quarter while the case in the next year hedge positions looks that it’s delayed until the crop is planted and harvested. Let’s now turn to Page 16, which shows the evolution of Adecoagro’s consolidated operational and financial performance. On a consolidated basis, net sales decreased year-over-year mainly explained by lower production volumes and the implementation of an aggressive ethanol carry strategy, partially offset by higher sugar and ethanol prices in dollars. Adjusted EBITDA in the second quarter of 2016 was $51.1 million representing a 7.6% increase compared to the second quarter of 2015. The improvement in financial performance was primarily driven by higher soybean and corn prices in Argentina and dilution of production cost with depreciation of the Argentine Peso and the Brazilian real combined with enhanced efficiencies in our operations. On a year-to-date basis, adjusted EBITDA stands at $94.4 million, 39% higher than last year. We expect Adecoagro’s production volume and financial performance to continue growing in line with historical low mainly driven by the consolidation of our sugarcane cluster and an increase in operational and financial efficiencies in each of our businesses. Let’s now turn to Slide 17 to take a look at our net cash position. As you may see on the top left chart, our gross indebtedness as of June 30 of 2016 stands at $791 million, and net debt stands at $623 million, essentially unchanged compared to the same period of last year. However, we expect net debt to fall during the third and fourth quarter as we start generating positive free cash flow. I’d like to highlight that 62% of our debt is in the long-term composed mainly of loans from multilateral banks such as BNDS at very competitive rates. To conclude, let’s move to Slide 18 to discuss our capital expenditures. Year-to-date, capital expenditures decreased by 35% reaching $63 million as anticipated this reduction is explained by the completion of the Ivinhema mill. We are currently expecting full year CapEx to reach approximately $110 million, of which approximately $70 million correspond to maintenance CapEx and $40 million to expansion CapEx. Expansion CapEx is currently related to the continuous harvest volume in the sugar and ethanol business. As explained, in the first quarter of 2016 earnings call, this new production model will allow us to crush approximately 1 million ton of sugarcane per year increasing nominal capacity from 10.2 million tons to 11.2 million tons. Although there is no investment CapEx required, we must invest in expanding our sugarcane area to be able to supply the growing capacity. In addition, expansion CapEx also includes marginal investments in our rice and dairy operations to expand capacity and improve operational efficiency. These investments are very high marginal returns. Despite increasing our CapEx forecast for the year, we continue expecting to generate free cash flow net of changes in borrowings in the range of $80 million to $90 million. Thank you very much for your time. We are now open to questions.

Thank you. [Operator Instructions] The first question comes from Thiago Duarte with BTG. Please go ahead.

Hi, good morning everyone. Well, I have two questions, one is related to this CapEx, projected CapEx that you mentioned in your last slide and the comment that you made on the free cash flow. So, just, on the CapEx is basically whether we should see, okay, understand that 2016 we should see the CapEx a little bit higher than what we were previously expecting on the back of this $40 million expansion CapEx. So, just wondering going forward, if we expect to have any incremental expansion CapEx at this point or if we should consider the $70 million as a good proxy of what you should see in terms of recurring CapEx in the coming years? And regarding the free cash flow, just to understand, you previously had, my understanding that you previously had this expectation of any $80 million to $90 million of free cash flow this year, before we had this higher CapEx? So just wondering why you think you are going to be able to meet this goal of $80 million to $90 million free cash flow, now if $40 million is more CapEx. So just wondering, what else you are seeing down the road, so that you are going to be able to offset the higher CapEx and keep the free cash flow guidance?

Hi, Thiago, this is Mariano.

Hi, Mariano.

On your first question, on your question on what should we expect going forward to 2017, the recurring CapEx of $70 million, I think, it sounds reasonable and it’s something that we could potentially expect. Regarding whether we could see some additional expansion of CapEx or not, as we always mention, we are going to be very disciplined on the return on investment that we could see there. So if we have very attractive projects like what we presented this year, like this expansion of 1 million tons more with very small investment of less than $30 million or this additional investments that we are talking in right that because of all the changes that happened in Argentina and we are, for example, transforming a pump station in rice field that we are transforming the pump station from diesel to electricity. This – the pay-off of this project is a year and a half, so returns are above 50%. So, as we continue to find these additional marginal projects with very high returns, we can see some additional investments, but only in that case and continue with our focus of being always the low cost producer on each of the commodities that we are producing. So, that’s the answer to your first question. Then, on the second question on whether these projected free cash flows of $80 million to $90 million why is it that we continue to project that, is because we are projecting our results and we are projecting our carry strategy et cetera, et cetera. That will continue to see this number in the free cash flow generation.

Okay, that’s good. Mariano, thank you very much. And if I could have a follow-up question, just to get your view a little bit, it’s been more than six months since you had a reduction in the export taxes in Argentina. My understanding is that the business environment in your sector has improved substantially since that happens, the currency has appreciated as well. So, just from the - looking specifically into the land transformation business, you guys have consistently sowed farms in the past, even when the business environment was not as compelling. So just wondering whether you are seeing good prospects in terms of more land monetization and land transformation land prices improving or anything like that. Just seeing in the real world whether this changing the taxation in the rather bitter business environment is really impacting your business in the form of seeing more bids for land, higher land prices something that we could expect to see even more and even better prices going forward. Thank you.

Okay, Thiago, good question. Basically, the returns of the land that we own have improved because of this improvement on the business environment all over Argentina. So, we do expect the prices of land to grow in line with what had happened on its profitability. So, in general, we would say that, we would expect higher prices of land for Argentina. In terms of our land transformation business, I would say that, we will continue to monetize in line with what we’ve been doing in the past and that’s something that we will be doing for ten years. So, we can expect that to continue to happen. And also to offset a little bit land prices, commodity prices for – sorry, for corn and soybeans have decreased compared to two year sales. So, that lower prices in commodity – in this commodity price, in this commodity are reducing the profitability of the land in the rest of the region except Argentina. So, for Uruguay, Brazil and Paraguay, we don’t expect prices to increase. We do expect as we’ve been telling some calls ago, prices do go down in terms of the land and that’s something we’ve been seeing.

Very helpful. Thank you, Mariano.

The next question comes from Isabella Simonato with Merrill Lynch. Please go ahead.

Good morning everyone. Thank you for the call. So I have a question on sugar and ethanol. You mentioned in the release that you’ve been quoting inventories of ethanol to sell in inter-harvest worst than always hopefully better. But, I’d like to understand better your view for this year specifically when we have potentially taxes coming back for the sector, what would be in your view the impact on prices and your view also on sugar prices going forward? Thank you.

Hi, Isabella. Good morning. Thank you for your question. I am going to ask Marcelo Sanchez, our Commercial Director to take this question. Marcelo?

Hi, Isabella. Regarding the taxes that are expected to be coming in, the PIS/COFINS tax, specifically in the ethanol, we understand that short-term impression may have a positive adjusted – in sales part of the charges that are coming, and of course, as this PIS/COFINS will be in place by January next year, starting in place by January next year most probably. The increase in the seasonal price of ethanol will be compensating that increase. Regarding the ethanol view, the sugar view in our – in the part of your question. I think that we are very positive for 2017 and we do think that we are going to be enjoying good prices for next year.

Thank you.

[Operator Instructions] The next question comes from Javier Martinez with Morgan Stanley. Please go ahead.

Hi, Mariano. I would like to ask you, if you can please share with us a little bit about the mood at the Board level, the mood regarding, what you should do with the cash that you are going to generate this year and the following year? I am trying to understand if the mandate you have is a consensus-weighted mandate? Is there is a debate on the Board? I want to understand the thresholds at which point is you don’t find the internal rate of return that you are looking for you will start to pay dividend. I would like to understand to try to map a little bit how is going to be that decision or when may we see a dividend coming on the table? Hello.

Hi, Javier, thank you for you questions. Yes, of course, this is a very important matter and it’s an important discussion that we are having at the Board and it’s a matter that of course we are always addressing. So, number one, we have a clear idea that for this year’s cash flow, we are going to be reducing that. So, we are – we will be certainly reducing debt as deferred debt. And then, after going below the two times EBITDA or a certain, there is not one specific number but, after we are reducing debt that’s the first step. Then the second one is, the discussion we are having every time, whether there is an accretive growth project or we will start giving dividends or buying back shares. So those alternatives are always in the table and we are always comparing any of the growth project with the alternatives to either give dividends or buyback shares. So, it will depend on what the projects that are presented or the IRR that we are presenting in the projects are accretive or not. So that’s basically now we think at the Board level.

Mariano, let me – obviously, this is my opinion, but let me question that the season always goes, at the end of the day you have a cost of leverage that is pretty low below 7% in Brazilian reals, 5% in US dollar, but with the capacity to generate higher return on debt and with a loan to value that is pretty low, so, why to reduce debt? Why don’t you buy shares or pay some dividend?

Okay, I understand what you are challenging. This cost of debt is what we have because of the growth projects that we had in the past. So that’s what we ask this level of debt to build what we build as a company, so to build basically this sugar and ethanol clusters. So from now on, after we review some of the debt level that we have today, we will start doing what you are saying or thinking that way.

I know, but again, sorry, sorry to be pain, but, you have low cost production, you have quite liquid high quality assets, you have a cost of debt that is pretty low, with below the rates in Brazil and you have the share prices trading with this company’s net asset value. So, that the Board – so is this a consensus-weighted view in the Board and that is the base use of the money?

This is, of course a discussion that happens at the Board level, and as of now, we have agreed that the first step is still reducing debt, because we feel comfortable in this business that is a volatile business where you don’t have full control of weather and commodity prices. We feel very comfortable with a lower level of debt.

Okay, understood.

Thank you, Javier.

The next question comes from Viccenzo Paternostro with Credit Suisse. Please go ahead.

Hello everyone. Thanks for the question. My first question is on the planning for the planting of the next season. I’d like to understand whether the potential La Nina could change your strategy for planting in the next season? I mean, we know that La Nina can severely affect the yields in Argentina. So what’s your view on that? And how this could change your planting strategy? That would be my first question. My second question is on the land transformation. Adecoagro has been selling $5 million to $10 million of land every year. I’d like to understand whether this is going to be the case for this year and for the next year? Thank you.

Okay, so regarding your first question on La Nina, we understand that today, the index is in a weak La Nina that would certainly benefit our crops, that would mean that we would have relatively dry weather in order to be able to have a good harvest on all our sugar ethanol and energy operations. So, that would be welcome for our own business and our own cash generation. And then, regarding corn and soybean planting for Argentina, we are in a very good situation of humidity all over the farm. So we will be able to plant in good conditions and we expect with a weak La Nina to continue having very interesting yields in both. Whether we are going to be planting more or less, we are growing a little bit in sugar, sorry, we are growing a little bit in corn and soybean past, we don’t have improved and in terms of sugarcane, we continue to plant sugarcane and we will continue to grow in order to be on the secure side and being able to have enough cane to continue milling at full capacity as we’ve been doing in the past two years. So, those are our strategies regarding this weak La Nina as we are seeing today. Then on the second part of your question - on your second question, we’ve been selling on generating someway more in the last ten years, that’s $5 million to $10 million, it’s more in $15 million to $20 million. And we expect to continue to be more or less in the same range and we are analyzing the sale of the farms according to its return on investment and we are always very disciplined on the analysis of the return on investments either for buying or selling any of the assets.

Perfect, thank you.

[Operator Instructions] Showing no further questions, this concludes our question and answer section. At this time, I would like to turn the floor back to Mr. Bosch for any closing remarks.

So, we are now in a very important time of the year in sugar, ethanol and energy business. We are in a most important period of the cane harvest and in the farming land transformation, we are entering into the main planting season. So, we have all our teams highly motivated and focused on execution. That’s how we see our business and the key of our business to focus on execution. So we hope to see you in our upcoming event and thank you for joining the call today.

Thank you. This concludes today’s presentation. You may disconnect your line at this time and have a nice day.