Pilgrim's Pride Corporation (PPC) Q4 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the Fourth Quarter and Year End 2016 Pilgrim's Pride Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] At the Company's request, this call is being recorded. Please note that the slides referenced during today's call are available for download from the Investor Relations section of the Company's website at www.pilgrims.com. After today's presentation, there will be an opportunity to ask questions. I would now like to turn the conference over to Dunham Winoto, Director of Investor Relations for Pilgrim's Pride. Please go ahead.

Good morning and thank you for joining us today, as we review our operating and financial results for the fourth quarter and year ended December 25, 2016. Yesterday, afternoon, we issued a press release providing an overview of our financial performance for the quarter and for the year, including a reconciliation of any non-GAAP measures we may discuss. A copy of the release is available in the Investor Relations section of our website, along with the slides we will reference during this call. These items have also been filed as 8-Ks and are available online at www.sec.gov. Presenting to you today are Bill Lovette, President and Chief Executive Officer; and Fabio Sandri, Chief Financial Officer. Before we begin our prepared remarks, I would like to remind everyone of our Safe Harbor disclaimer. Today's call may contain certain forward-looking statements that represent our outlook and current expectations as of the day of this release. Other additional factors not anticipated by management may cause actual results to differ materially from those projected in these forward-looking statements. Further information concerning those factors has been provided in today's press release, our 10-K and our regular filings with the SEC. I'd now like to turn the call over to Bill Lovette.

Thank you, Dunham. Good morning everyone. Thank you for all joining us today. For the full year 2016, net revenues were $7.93 billion versus $8.18 billion from a year ago, resulting in an adjusted EBITDA of $899 million or 11.3% margin versus $1.21 billion a year ago or 14.8% margin. Our net income was $441 million compared to $646 million in the same period in 2015 while adjusted earnings were $1.75 per share compared to $2.60 a share in the year before. For the fourth quarter of 2016, net revenues were $1.19 billion versus $1.96 billion from a year ago resulting in an adjusted EBITDA of $170 million or 9% margin versus $150 million a year ago or 7.7% margin. Our net income was $71 million compared to $63 million in the same period in 2015 while adjusted earnings were $0.30 a share compared to $0.26 a share in the year before. Our team achieved solid performance in 2016 as we closed the year in a positive trend. 2016 was a more challenging year than we initially expected, but presented many positive highlights of which we can be proud. We announced our entry into USDA certified organic chicken production to strengthen our partnership with key customers while positioning us to be the largest organic chicken producer and complementing our ABF leadership. Last year, we were more than half way towards our goal of having 25% of our production to be ABF by the end of 2018. And if we consider only the non-commodity portion of our production, the same target translates to roughly 40% of our chickens. We diversified our geographical processing footprint in the Upper Midwest by acquiring the GNP Company and accelerated the non-commodity ABF share of our chicken production beyond our legacy facilities; and prepared foods our vision for sustained growth has remained intact. We started the plant expansion of Moorefield, West Virginia, which will add to our higher margin full-equipped capacity by 10% starting in quarter one, and we completely revamped our Waco Texas facility that will be producing at normal capacity by the end of the current quarter. All these mixed changes in investments had an impact on our operational improvement target, as they increased overall production cost, but will translate into a more consistent and higher margin profile business for the future. Our newly acquired assets in Mexico continue to perform well, now with margins approaching those of our legacy operations. We exceeded our expected synergy capture by close to $10 million annually. We're continuing to further increase production at our new Veracruz complex and expect to significantly expand the size of the supporting operations this year. Yet these efforts are all part of our strategy to further de-commoditize our portfolio would bring less volatility in our performance as well as better margins. Last, but not least, we paid $700 million in special dividends following the $1.5 billion that was initiated the year before signifying our strong cash flow generation potential, and a focus on maximizing capital structure and shareholder value. Our fresh business continued to perform well during Q4, driven by our portfolio strategy of a well balanced mix of multiple bird sizes and geographical coverage in conjunction with the diversity of our product and channel exposure. Our presence in all bird size is small, tray-pack, and large is a powerful advantage that gives us a differentiated platform versus our competition with a narrowed focus. Each bird category has its own specific supply and demand dynamics, and our portfolio diversity gives us the potential to offset the strength and weakness within each individual market to deliver better overall performance. To give more color on the individual markets, our case ready and small bird operations continue to deliver strong performance and our leadership in these markets is giving us an edge over the competition. Despite greater availability of other proteins demand for chicken particularly at retail has remained very robust. Traffic at grocery stores has been strong driving demand for our retail customers, which is a positive sign that consumers' appetite for chicken, despite concerns about competing protein, has not been impacted. Reflecting the solid market conditions in these segments, the EMI small bird index remained very stable similar to the Georgia Dock index before it. We expect small and case ready birds to continue to have favorable market conditions, given the reduction in processing facilities over the years, there while producers continue to prioritize new capacities on larger birds, within the large bird deboning prices and demand continue to recover relative to last year supported by stronger export markets. Although, profits for large bird deboning are still not yet at a comparable level to the other categories, the strengths of the back half in wings will help solidified returns in this segment and contribute to a better cut out. We're very excited about our most recent acquisition the GNP Company. This satisfied our chicken track strategy of filling voids both geographically and with consumer facing brands, located in Minnesota the nation's fourth largest corn producing state and Wisconsin. This gives our production marketing footprint a stronghold in the upper Midwest an area in which we were not strong before. It also provides a sustainable competitive advantage with the Gold'n Plump brand, which is ranked second among national brands in the Upper Midwest region of the U.S. Further, our new Just BARE chicken, the third ranked national brand in the same region is rapidly growing at a CAGR of 20% the past five years, and we believe it has transformational growth potential as our national go-to-market offering for the most desired on trend consumer chicken brand. That said, the most exciting part of adding GNP to our family is the dedicated and passionate team of professionals who lead the business and the local support of the St. Cloud, LaBorne and Cold Spring, Minnesota and Arcadia Wisconsin communities. Export markets in Q4 have remained steady, which is a positive for the back half of the bird and also supported for improving the overall cut out. The absence of avian influenza outbreak domestically as well as challenges experienced by other export sources due to bird diseases in the EU and Asia, demand pricing for U.S. exports has been gaining momentum since the beginning of last year, and we believe this improvement can be sustained into 2017. Year-over-year pricing for leg quarters has increased nearly 40% from last year's levels, reflecting strong international demand for U.S. chicken. Inventories for leg quarters and other export oriented cuts have significantly declined from last year as global export shipments and demand have been so strong. Market demand in Mexico was in line with expectations during Q4 and prices remain stable throughout the quarter. Our operations produce very solid results; however, the strong dollar which appreciated 20% plus in Q4 alone diminished the contribution to the consolidated results. As we said before although Mexico continues to have more volatility than the U.S. quarter-to-quarter, we expect it to be a double digit contributor through our profits. In terms of expectations for 2017, we believe Mexican producers will increase production by another 2% to 3% in line with the growth of 2016 and for market conditions to continue to be in good balance. Although, we already have a strong position in Mexico, we're continuing with our product innovation. Last November, we launched our new family of Pilgrims, branded value-added products both par-fried and fully cooked, which was very well received in the market. We had high expectations that our strategy of leveraging the premium Pilgrim's brand, well known for high quality and excellent service, will be a success. At the same time, we're continuing to grow our market share of the established Del Dia brand, which is geared toward the largest consumer group in Mexico those looking for the best value. In 2017, we've many new excited products which we'll be introducing under this brand. We believe that we've a strong team in place in Mexico with the right structure, the best product mix, flexibility and great customer service while always improving our operational performance. On feed costs, corn prices have stayed in a relatively narrow range since the beginning of Q4, reflecting the ample corn supplies in the U.S. and in addition to the large global grain stocks. Soybean meal prices rallied in January as market participants begun to worry that heavy rains in Argentina would affect production for the recently planted crop. This increase in soybean meal futures has been partially offset by decrease in domestic premiums, which are trading at historical low levels. A drier weather forecast in Argentina has taken out some of the enthusiasm for soybean meal; however, we do not expect feed costs to be a hurdle for margins in the medium term. For 2017, we expect total industry production to increase by 2% mostly on heads, as we believe that there's less incentive for producers to materially increase bird weights compared to recent years that bird weights are closed to optimum now. While strong U.S. economic conditions are a positive for demand, we continue to see some signs of labor tightness affecting staffing availability across the industry especially for new operations, which is another factor that could impact production growth for the whole industry in 2017. We continue to believe that the announced capacity additions to the industry over the next few years will be well supportive of a balanced supply demand environment, and we remain convinced that our business will have the ability to outperform given our broad portfolio and presence in all bird categories as well as strong relationships with key customers. And as our key customers typically have better growth profile than their peers, our partnerships with them created an opportunity for us to further accelerate growth in key categories while giving us strategic advantage and reducing the transactional nature each relationship. Despite production growth from other proteins, the outlook for chicken demand in 2017 should remain very solid, as we believe robust export environment will absorb much of the increase in total U.S. production across all protein complexes, while strong U.S. economic conditions including a very low unemployment and improvement in disposable income will drive households to ask for better quality, higher price cuts in meat and also more overall consumption. While we're already well balanced in terms of our bird size exposure, we'll continue to look for opportunities to shift our product mix and reduce the commodity portion of our portfolio by offering more differentiated specialty products to key customers, while also optimizing our operations by pursuing our operational improvement With that, I'd like to ask our CFO Fabio Sandri to discuss our financial results.

Thank you, Bill, and good morning everyone. For the full year 2016, net revenues were 7.93 billion versus 8.18 billion from a year ago. We have an adjusted EBITDA of 899 million or an 11.3% margin compared to 1.21 billion or a 14.8% margin for the year prior. Adjusted EPS was 1.75 compared to 2.60 in the year before. Operating margins were 9% in the U.S. and 11% in Mexico. We reported 1.91 billion in net revenue during the fourth quarter of 2016, resulting in an adjusted EBITDA of a 172 million or a 9% margin. That compares to 1.96 billion in net revenue and an adjusted EBITDA of a 150 million or a 7.7% margin the year before. Net income was 71 million versus 63 million in the same quarter of 2015 or a 13% year over year increase, resulting in adjusted earnings per share of $0.30 compared to $0.26 in the same quarter of last year. Our fresh chicken operations continue to generate very solid results. Demand for case ready and small birds remains strong, while the commodity markets continue to improve as the environment for U.S. exports improved from a year ago, which is supported for the back of the bird pricing, overall cut ups and margins. Despite better availability of other protein, chicken has continued to be an excellent value to customers both in terms of overall price and in convenience for the end users. In 2016, we invested a total of $270 million in CapEx, an amount significantly higher than our depreciation in part to optimize our product mix. While this strategic project seen as improving our ability to supply differentiated, less commoditized products and sync in partnerships with key customers, they had an impact on our operation improvement target and our results in the short term have increased the overall production costs or reduced short-term production. Despite the short-term impact, the strategic projects we are undergoing especially organic plants and the investments in prepared foods will enable us to build a more consistent and higher profile margin profile for the business. We expect the large portfolio improvement projects we announced last year to be completed by the end of Q1. The Mexican markets were in line with expectations during Q4 and our operations produced a strong results specially compared to the same period last year. Our performance reflected a favorable domestic supply demand environment, despite the strengthening of the dollar against the peso throughout the quarter. The integration of the acquired operation is almost completed, and we exceeded our prior synergy targets by $10 million, which is a positive sign of the potential opportunities we have within those facilities to further strengthen our geographical and private coverage as well as our margin performance. As we have mentioned production at the new Veracruz facility is proceeding well and its performance is exceeding our expectations. We consider Veracruz a key pillar in our growth within the Mexican markets, also to supplement the strong demand in the popular Del Dia brand and grow our prepared foods in Mexico. We launched value-added products using the Pilgrim's name to expand and strengthen our presence across all consumer channels and income levels. Our goal is to produce coverage starting from the entry level all the way up to the premium segment, both fresh and prepared in Mexico. During Q4 2016, we also increased our accruals for variable compensation, reflecting the performance of our individual business units. For 2017, we'll continue to target SG&A expenses to be close to 2.5% of net sales, as we focus on adding value to our operations. We continue in our strategy to capture operational improvements every year to add to the total when we first implemented the profits five years ago, as our team continues to be relentless in their pursuit of operational excellence regardless of market conditions. While our mix and production capabilities are continuously evolving to support the relationship with our key customers, our key members have identified and created action plans to capture a $174 million in additional operational improvements during 2017, including the announced strategic projects to improve our portfolio mix which we expect to flow through the bottom line. Of those, a $174 million in additional operational improvements, a $100 million we'll show in cost reduction either through more efficient operation or improved with life cost, and $74 million we'll show in sales through better use and better mix. Our balance sheet continues to be robust, due to our continued emphasis on cash flows from operating activities, focus on management of working capital and disciplined investments. During the quarter, we generated operating cash flow of $224 million; including the payments of $700 in special dividend back in Q2, our net debt reached $892 million with a leverage ratio below one-time last 12 months EBITDA. Our leverage continues to be low and underlines how much strength we have to fulfill our strategic actions. The outlook for interest expense for 2017 should remain in the range of $30 million to $40 million. As we continue to generate strong cash flows, we expect to sustain the pace of investments in our operations throughout 2017. As I comment before, we exceeded our initial CapEx targets for 2016 and invested $270 million, which indicates our commitment to spend cash flows on strong return over investment projects, that will strengthen our operational efficiencies and tailored customer needs to further improve competitive advantages for us. For 2017, we expect our strategic capital projects to continue to move at a fast pace with the CapEx target of $220 million which is also above our depreciation. We closed the acquisition of GNP Company during January. The acquisition was fully aligned with the chicken track parts of our strategy, adding to our portfolio both geographically and on consumer faith in brand. Integration is on track and we have already the five additional synergies to add to our $20 million in initial expectations. More importantly, we believe there's a great potential to lever just their product line, our fast growing on trend consumer chicken brand across our entire national portfolio including prepared foods. Since the beginning of the share buyback program, we've purchased more than $270 million in shares on the open market, while maintaining a strong balance sheet and a low leverage. Once again, we're confident of our ability to return cash to shareholders and exercise great care in ensuring that the both share repurchase and the dividend payments, not only create shareholder value, but also preserves our flexibility to pursue our growth strategy. We'll continue to consider and evaluate all relevant capital allocation strategies and will match the pursuit of our growth strategies, and we'll continue to review each prospect according to our value creating standards. Operator, this concludes our prepared remarks. Please open the call for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from Farha Aslam from Stephens Inc. Please go ahead.

Could you just go through the costs that flowed through your P&L in 2016, kind of the projects that were related to it? You touch on a few. How much can we expect will flow through in 2017, or how much would be absent?

Farha, the cost that flow through 2016 is not only the cost of that we invested, as we mentioned, we invested $270 million. It's also when we put some plants down, we have less production. For this year, we have our own 3% less output from our plants, which increased our costs. That relates to around $400 million less in sales and respective margins for those products. But like we mentioned, we believe that that will strengthen our portfolio into a more less commodity profits.

So as we look into 2017, can we expect that volumes will come back to that 3% volume, will come back? How should we think about the sales? Will that equate to another [$40 billion] sales coming back to you, and what kind of margin improvement opportunity do we get without supplies being down. Any color would be helpful?

Sure, Farha I'll take that. We do expect in 2017, our volumes could to be stored to our historic production levels that we expected in 2016, and in addition to that, we expect that the projects that we completed, not only at the end of 2016, but couple in early 2017 by the end of the current quarter, will not only increase our production but also improve our mix which over time will help margin up our entire portfolio, as we said. So, again part of that was due to some needed repair and maintenance on some of our facilities, other projects were about growing our value added business. But all in all, we completed or will complete about $200 million of CapEx that we believe will contribute to the $174 million improvement goal that we expect to realize in 2017.

That's helpful. Then my final question. Bill, you were very specific in the releasing thought particularly to impact -- could you share with us your confidence around that statement?

Farha, you were cutting out there in your question. So, I didn't -- I did not hear all of your question. Could you repeat that?

Sure. In your release, you were very specific and noted that you do not expect chicken pricing to be impacted by competing meat. Could you share with us more color on what gives you confidence around that statement?

I was talking more about demand at retail that was particularly overall chicken prices. We've seen demand at retail as is normal during January, be very robust especially with our key customers. I can't speak to for others, but while we believe that we'll see perhaps 4% or 5% more beef available in the U.S. and perhaps 2% more pork, we believe that chicken will remain a great value to the consumers as there's still a significant spread at retail prices from beef to chicken and also from pork to chicken. And we also believe that the export environment would be very health and will clear some of this added production as well. So, we don't see a significant impact for demand for chicken in 2017 due to the competing meat environment, and we believe chicken will remain very strong in demand.

I'll just add Farha that as we diversify our portfolio into more value-added products like organic and ABF. Those segments are less affected by the competition of other proteins like more commodity segments. So, we need to look into the overall all of that we're building and that portfolio is a lot stronger than just commodity products.

Our next question will comes from Kenneth Zaslow of BMO Capital Markets. Please go ahead.

I have two questions just big picture question. As I look at your prepared-chicken business over the last five years and into '16, it continues to go down. Where will we see the inflection point of prepared foods, where maybe we would actually start to see growth in that business? And when I think longer term, where would you think the prepared foods business would be relative to your mix?

As you recall, Ken, much of that decrease in our portfolio prepared foods was on purpose. We, in the early days of our arrival 2011, 2012, we got out of some unprofitable business, and we reset our production footprint with the focus on margin as opposed to a focus on just value-added sales. You asked about the inflection point, I'd tell you that we're there now from where we're today with the investments that we have made and continue to make in our prepared foods production footprint. We've a strong desire to now grow prepared foods as a percentage of our portfolio; and I think over the next five years, you can see that the percentage I think has a chance to double from where it is currently.

I think, Ken, we already announced that we're implementing the line in Moorefield, West Virginia; and we expect our volumes in the prepared foods to increase by 10% in 2017.

That's off the depressed number of 2016? You are not getting it back to where you thought you would be before the challenges, plus 10%, it's 10% off what you are right now? Is that fair just trying to figure that out?

As we continue to ramp up the operations, and we expect to be fully operational at the full capacity in Q1. We expect to add 10% to our capacity, so you get back to the volumes that we had previously.

Okay. And then my second, just brought question is with the changing administration, can you talk about, how you are preparing and how that would affect your business in terms of your Mexican operation, as well as acquiring corn, and just how you're thinking about how you are positioning, given the new presidential -- just seeing how you are thinking about that?

Ken, we're always concerned with our government's relationship with Mexico as the U.S. and Mexico are very important trade partners. For example, Mexico being the 15th largest economy and the 11th largest in purchasing power, Mexico imports about 4% of the U.S. corn crop, the U.S. imports over $11 billion in fruits and vegetables and over a $100 billion in auto parts, trucks, cars, and buses. So, that's the reason, we believe that our relationship will continue to be strong, and we'll manage on both sides. The Bank of Mexico predicts that during 2017, GDP will grow from 1.5% to 2.5%. We are seeing some inflation in Mexico particularly in December, the inflation rate annualized at 3.36%, which is actually the highest that we've seen in three years. On the other hand, the minimum wage has been raised in Mexico to 80 pesos per day from 73. We've seen fuel and electricity as well as other cost rise, but on the other hand unemployment rate remains very low in Mexico and there are many factors that point to actually a strengthening economy from a consumer standpoint in Mexico. And so, we're not changing our strategy as a result of anything that you mentioned. We plan to grow our presence in value-added branded chicken over the next five years, and we also plan to grow our production levels and our market share in Mexico. And one of the things I would point out that, in our position as the number two producer of chicken in Mexico that gives us a competitive advantage to other U.S. companies who do not have that as it provides an offsetting effect to any potential trade conflicts with the U.S.

On the export picture, any worries or any concerns on the exports? You kind of came up seeing very strong export picture, you don't think that there'll be any trade disruptions at all, is that your view?

We don't see anything to be overly concerned about at this moment, no.

[Operator Instructions] Our next question will come from Heather Jones from Vertical Group. Please go ahead.

So, I have a couple of relatively simple questions and I want to get into the prepared foods conversation in depth, but going back to your comment on the EMI small bird index. So, I understand, if they have been working on an index that could possibly replace the Georgia Dock index for retail contracts, and I was wondering if you could speak to that?

Heather that index has been an index for quite some time and is tracked very closely to the Georgia Dock. I believe there's a slide in our investor presentation that we put online this morning that reflects that, and it's our intent to use that index as a pricing mechanism at retail and in food services as well as we've been doing actually for quite a long period of time.

And, Heather, I'll just add like we mentioned before less than 5% of our contracts were based directly or indirectly in the Georgia Dock index. And like I mentioned, as we increase the differentiation of our products, Georgia Dock or any other market index is less important to us.

Secondly, and you said, you had issues with prepared during 2016, but in your fresh business. How are you guys tracking relative to your peers and your small bird tray packing your large bird segments? I remember over the last several years, you had made a lot of progress and it moved substantially higher and into these categories. I just wonder, if you could give us an update on where you stand now?

We continue to be very-very competitive, if not, one of the best in our tray pack or case ready operations as well as small bird. We've leading positions in both. We further differentiated our product line especially in case ready to a more ABF veg-fed meeting the needs of our key customers. I would tell you that the one challenging area that we're not at all happy with right now are large bird deboning business. We grew rapidly over the last five years in that business and that's an area that we challenge our management team to get much better at and we got I believe the right team in place to do that; we've made investments in our operations to reflect that desire and we look forward to getting much better in that segment in 2017.

And just in the portfolio transformation that we're doing, our plant in Sanford, North Carolina has been transformed from a big bird plant to a case ready organic plant in partnership with one of our key customers. So, we're always changing our portfolio to reflect our expectations in the future in our performance.

And what percent of your large bird production did Sanford represent? I had understood it was like I don't know 650,000, 700,000 bird a week, but was it 10% of your big bird production I mean how should we think about that?

That's in the ballpark.

And then my final question is going to this prepared chicken -- so if we look at the numbers that are in you K is roughly 400 million decline in '16 versus '15, and based upon average prices, I mean it sounds like that's probably somewhere between £200 million and £225 million. And my understanding clearly prepared food tends to be higher margin, but industry averages they would apply margins anywhere from 50% to 100% higher than average fresh margins. So, if I think about that it seems like those pounds could have cost you -- losing those pounds could have cost you somewhere on the order of about $40 million or so. And so I'm just trying to sense going forward into 2017, you get those pounds back plus you get the expanded production, that it could be a very nice tailwind for you guys that, that would help counter some of the pricing pressure in some other areas of your business. So I was wondering if you could -- does my thinking make sense there?

Heather, generally, I think you've described it pretty well. I would tell you that we look at prepared foods, not necessarily as higher margin, but more consistent margin. And we use that business to offset some of the more commoditized portion of our portfolio. If you look at our tray pack business and even some of our small bird portfolio, those margins actually are higher than prepared foods. But you know the way we look at it each portion of that portfolio plays a specific role, and for that reason we desire to grow that prepared foods business for those two reasons. One, higher margin than or less volatile margin than our commodity oriented business and more consistent. And we want to grow that as a part of our portfolio. So, I think generally speaking you characterized that pretty accurately.

Just to add to the calculation that I just did, as we have less pounds, we maintained our labor force that is high skilled in those prepared food plants. So, we have a much higher unit cost because of the lower pounds.

And one of the things we have not pointed out, Heather, that did contribute to volume changes, that is lowering volume is we deboned a lot more of our leg quarters in 2016 than we historically had and so when we report the sales pounds, the bones in trim are not included. So, if we were to sell a leg quarter, you got the bones in the back included as opposed to selling boneless leg meat. You don't have the back and you don't have the bones over the trim. So, it’s much less volume, but it provides a much or has provided a much better cut out and that's why we did it.

Yes, typically, we expect $0.05 to $0.07 premium in terms of margins by deboning, compared to selling plain leg quarter.

Okay and forgive me for taking a little more time, but I just want to clarify something. So, I understand that further process may not be higher margin and tray pack in small bird, but if I take your fresh U.S. business in total, so all the commodity elements of large bird rendering whatever, is prepared foods' higher margin than that fresh business in total?

We expect it to be in the range, if not slightly higher in margin, as we improve our mix, I think that's a fair assessment.

Our next question will come from Adam Samuelson of Goldman Sachs. Please go ahead.

Maybe kind of staying in prepared a little bit and two questions. First, I want to follow up on Heather's kind of question on the profit kind of hit that you resolved in '16, Fabio, you've kind of alluded higher unit cost associated with the loss production, mean, if it’s 40 million would be the normal -- 40 million or so, if it is normal EBIT associated with the loss sales, but you still have the stranded overhead labor. I mean is that -- should we be thinking from an incremental potential up to $100 million from those items as you've have the proper overhead coverage in 2017?

Yes, in that of magnitude, like I mentioned we keep all the overhead there to train our labor force even while we were doing the rebuilding of the plant.

Okay, that's helpful. And then within prepared, there's a commentary off late that we've seen I mean you talked about contracting for 2017. It seems like some of the prepared categories had a more difficult contracting around this year, certainly than last year and if that had any impact at all in your 4Q results?

No, that didn't have near as an impact as our operational issues had.

Okay. As you look at 2017, have you seen any -- how do you characterize that competitive landscape on prepared or the processed items versus last year or last couple of years, especially given good service environment that it's been tougher recently?

Yes, that's a good point. I think 2017 is somewhat of a more challenging environment, as compared to the last two to three years, but didn't have any impact on us. What we want to do in 2017 is, restore our production capabilities, restore the confidence with our customers, our key customers and our ability to supply them and get our volume back throughout the year.

Thank you. [Operator Instructions] Our next question comes from Michael Piken of Cleveland Research. Please go ahead.

I just wanted to touch a little bit more on ABF and whether you still think you're on track to eventually get the 25% of your volume from ABF and what do you think it's going to happen to the industry current premiums as more people enter that space?

We're actually ahead of schedule on reaching that 25% as we said in the prepared remarks. We've had some key customers come to us and ask for specific products in that line, and we've been able to deliver that which has helped us grow that a higher rate. The acquisition of GNP Company also provided for more growth in that segment as that was their model as well on the two brands, Gold'n Plump and Just BARE. So, we think we're ahead of schedule for our original goal. Obviously, to your second part of the question, will those products be commoditized overtime? I would say perhaps, but our strategy is really less about ABF and more about tailoring these products to specific needs of our key customers. So, we're not doing this out of speculation, we're doing this because we have relationships with key customers who've identified a need for their product line and then we've gone back and delivered against those needs and that's why that our growth is what it is in ABF as opposed to our speculating about where the markets going to go or not go.

Shifting gears, you guys talked about the strength in retail, but could you talk it all about some of the trends you're seeing in food service and how do you expect that to play out over the course of the year?

What we see in food service is fast casual growing at a much more rapid rate than any other segment in food service. Some QSR formats are growing some are not. Casual dining has been the weakest part of the food service business. We don't play to the large degree in casual dining. We've chosen to put more of our product in fast casual and QSR. And so our business in food service, I don't believe is reflective of total food service as we've chosen to follow our key customers into the channels that -- or segments that are growing at a more rapid rate.

Okay, great. Then lastly anything that you could provide in terms of color on the cadence of how you expect Mexico to play out would be helpful in terms of Puerto Rico? I know there's a lot more volatility down there, but would you expect it to follow the same type of pattern we saw in '16 or would you expect more steady margin profile throughout the course of the year? Thanks.

We have no reason to believe that 2017 will be different from a seasonality standpoint than any other year, it's sort of shaping up to be like a normal year down there for us, actually Q4 was much stronger than the previous year and we started out in 2017 Q1 in a stronger position from a demand and pricing standpoint and the other thing that I would point out is operationally we continue to improve in Mexico so it’s all good news as far as we're concerned.

Our next question will come from Akshay Jagdale of Jefferies. Please go ahead.

I just had to jump on the call, so if I missed something please excuse me for that. But did you -- did you talk at all about this quarter and how it came in relative to your expectations because obviously you don't give quarterly guidance, but generally, you thought Q4 was going to be very similar to 3Q? I'm just wondering what caused the sequential deterioration in the business, so can you comment on that?

Just to compare this quarter with the same quarter last year, this was an improvement. So, we saw 13% better returns this quarter than the same quarter last year. So, we saw an improvement in the overall market. In terms of the overall production, we continue to change our portfolio. So, we talk about this in the previous quarter on all the changes we're doing on the prepared foods operation and on the Sanford operation, so that contributes to the lower volume in Q4. But we believe there will be better margin profile for the future and that's why we were doing that.

Sure and I appreciate that, but just looking, I know year-over-year it's slightly better, but last year this quarter was -- it was pretty weak and your U.S. margins about the weakest they've been since 2013, first quarter. So I'm just trying to understand how much of that is like issues with the prepared foods business that carried over and certain aggressive actions you may have taken to improve your mix that might have impacted you short-term, because you haven’t seen this type of deterioration, let's say in the market place industry margins-wise. Relative to the industry, it looks like you did slightly worse, so I'm just trying to gauge that aspect.

I'll tell you Akshay for sure, we did, in the fourth quarter. We did have some effects of our prepared foods issues. We do expect as we've said to have our production back at more normalized rates by the end of this current quarter so we expect that will be behind us. In the fourth quarter this year, one of the factors that provided for the improvement was the back half the chicken pricing was much better than it was the previous year, as we were coming out of the effects of avian influenza from the previous year from an overall pricing standpoint. As we've said in the prepared remarks, our case ready business and our small bird business continues to be very robust. The large bird deboning environment has been not as strong as in some periods as you point out, but the other segments are much better and that’s why our portfolio strategy has benefitted us, we believe more than other producers.

And can you -- the strategic capital investment, which obviously was a step up even relative to last quarter's CapEx guidance. What is that? What exactly are you spending that 70 million, 80 million for the exactly the number incremental CapEx on? What were you doing with that exactly?

So, as we've talked about now for the last three or four quarters, we converted a big bird plant to a case ready plant, we'll be the largest producer of certified organic chicken in the nation as a result of that. We also put in a brand new full equipped plan our Moorefield, West Virginia plant. That should increase our prepared foods production by 10% from what it was. We did a project in our Mayfield, Kentucky plant to move bone-in 8-piece production to boneless production for key customers. So those are the primary ones. In addition to that, we completely refilled our Waco, Texas plant and set it up for being able to produce at a higher rate of production than it has been in 2016.

And just one last one from me, as it relates to retail price discovery. I know you and one of your largest competitors had come out and said that obviously the Georgia Dock is not a big percentage of your sales or your revenue does not really tied to Georgia Dock. Can you just talk a little bit more about how your retail price discovery mechanisms work today? And if anything has changed at all with all the focus on this pricing issue, the negative commentary and one of your competitors getting subpoenaed by the SEC on this, I mean can you just help us understand what's happening at the customer level, like with all the questions surrounding pricing? Thank you.

For us, nothing has changed in our strategy or our practice in terms of pricing our retail tray pack production. Our relationships with our key customers provide for a relationship such that price is one of the -- not the most important factor and so again, for that reason, nothing changed in our pricing strategy because of any particular price discovery mechanism or index or anything else.

Just to add to that Akshay, we didn't have any discussion with any customer about this issue. It was more I'd say a question because we have very intelligent buyers and this price is part of a much larger discussion about quality, services and tailoring out our products, and as we mentioned this is a price discovery mechanism not a price determination.

Our next question will come from Bryan Hunt of Wells Fargo Securities. Please go ahead.

I was wondering, you all always have efficiency improvements projects in the pipeline and you talked about how you know all the plants re-org and movements that you made in 2016 kind of muddled the picture. I was wondering as you look to the projects that you're undertaking into 2017, is it possible for you to separate your anticipated efficiency in mix gains from recovering what you've lost in 2016 from the disruptions?

Yes. So, like we mentioned, we expect that a $174 million additional operational improvement during '17 and that includes the strategic projects and also specific projects in other business and other plants. Of those, a $100 million is cost reduction in terms of more efficient operation, reduced labor cost, more automation, improved live cost and $74 million will be better yields and better mix that we'll show in sales.

Thank you for separating those out, Fabio. I was wondering can you -- kind of completely switching gears and looking at capital. Can you give us an idea of what's left under your current repurchase program?

We repurchased close to $270 million out of goal or target of $300 million. So, we have around $80 million to $85 million.

And I guess looking at the potential for free cash flow this year. Is there a reason not to expect that you would continue to buyback under that program?

So we, yes, we'll continue with the program.

All right. And then you know you talk about looking at ongoing M&A, can you -- what's the -- what's the universe of opportunities out there today versus maybe when you completed Gold'n Plump?

I don't think the universe is really changed Bryan. We continue to look very particularly at both the chicken track as I described in the prepared remarks looking for geographic and consumer facing plan voids. I think GNP is a great example of that. On the processed meats track, again nothing changed for what we're looking at. We continue to look at deals that are available and we're going to go for value and not just go for top line or growth.

And Bryan, our value creations strategy is building synergies, operational excellence and more consistent earnings; and we have the balance sheet strengths to pursue those type of opportunities.

Ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Lovette for any closing remarks.

Thank you. We're looking forward to 2017 with feed costs expectations remaining good. Our outlook is for chicken demand to continue to remain quite solid, as we believe the increase in total U.S. production costs, all protein complexes will be met with greater export demand while the strong U.S. economy should drive more protein consumption across the board and absorb the supplies. With the addition of the GNP Company to our family, we have plans in place to leverage the strength with their brands as the national go-to-market offering for the most sought after consumer chicken brand. We expect our cash flow generation to continue to be strong allowing us to sustain the investments in strategic projects this year at a similar pace to last year further strengthening our operational efficiencies and tailored customer needs to further improve competitive advantages for Pilgrim's. We'd like to thank our team members and our customers as always and appreciate your interest in our company. Thank you all for joining us today.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.