Earnings Call Transcript - PPC Q1 2021

Operator, Operator

Good morning, and welcome to the First Quarter 2021 Pilgrim's Pride Earnings Conference Call and Webcast. This call is being recorded at the company's request. 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. I would now like to turn the conference to Dunham Winoto, Head of Investor Relations Corporate. Thank you, and over to you.

Dunham Winoto, Head of Investor Relations

Good morning, and thank you for joining us today as we review our operating and financial results for the first quarter ended March 28, 2021. Yesterday afternoon, we issued a press release providing an overview of our financial performance for the quarter, including a reconciliation of any non-GAAP measures that we discuss. A copy of the release is available on the Investor Relations section on our website, along with the slides we'll reference during this call. These items have also been filed as Form 8-K and are available online at www.sec.gov. Presenting to you today are Fabio Sandri, our President and Chief Executive Officer; and Matt Galvanoni, Chief Financial Officer. Before we begin our prepared remarks, I'd 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 date of this release. Other additional factors not anticipated by management could cause our actual results to differ materially from those projected in these forward-looking statements. Further information considering those factors has been provided in today's press release, on Form-8K and our regular filings with the SEC. I would like to turn the call over to Fabio Sandri.

Fabio Sandri, President and CEO

Thank you, Dunham. Good morning, everyone, and thank you for joining us today. For the first quarter of 2021, we reported net revenues of $3.2 billion and adjusted EBITDA of $254 million or a 7.8% margin compared to 5.4% a year ago. In addition, we offered a $100 incentive bonus for every team member who chooses to be vaccinated. We have halted operations in several locations during vaccinations to facilitate higher participation rates. We have safety protocols above all standards, and coupled with higher vaccination rates at our facilities will continue to result in a safe working environment for our team members. We thank our governors and other state authorities who have supported vaccination of our workforce in many of the locations where we operate. In terms of direct COVID-19 mitigating costs, we accounted for roughly $30 million for the quarter. Countering the significant challenge over the last 12 months, our portfolio strategy has continued to generate superior relative performance, outpacing the competition by delivering more than a 50% increase in adjusted EBITDA for Q1. The results were driven by our resilient business model across all business units, including the U.S., Mexico, and Europe. The unique challenges as a result of COVID-19 presented an opportunity to demonstrate the value and strength of our well-diversified portfolio, including our presence in the world and our ability to generate more consistent results despite specific market volatility. Our performance is the result of our vision to become the best and most respected company, creating the opportunity for a better future for our team members. To support our vision, we are continuing our strategy of developing a differentiated portfolio of diverse, complementary business models, continuing to relentlessly pursue operational excellence, becoming a more valuable partner to our customers, and creating an environment for safe people, safe products, and healthy assets. Our team members have remained focused on executing and delivering on our strategy, regardless of individual market conditions. Our adjusted bird revenues continued to see incremental improvements in many of our markets. While some challenges remain, we continue to adapt by making internal changes to our operations to align with market conditions. We are committed to delivering strong growth and achieving a significant increase in relative performance against industry peers across all of our global operations. During Q1 in the U.S., our retail and QSR business has remained solid due to strong demand across our customer base, despite high input and operating costs and less than optimal mix due to labor shortages. The market for commodities in March experienced the largest improvement compared to the same period a year ago. Our prepared food business remains resilient despite the challenging demand environment, and the business continues to grow its sales, reflecting the investments made over the past few years and in anticipation of strong results as COVID-19 restrictions are rapidly lifted throughout 2021. In Q1, despite significant changes in feed costs and lower volume due to lockdowns, our combined European operations, Moypark and in the U.K., continue to generate good performance. In Mexico, the market remains very favorable with strong results in the quarter compared to a very difficult Q1 of 2020. For 2021, we will maintain our strategy while continuing to improve our portfolio to be responsive and resilient to individual market dynamics, and create relative performance over the competition. We believe this approach will yield higher and more consistent results for the mid- to long-run and minimize the full peaks and troughs of the volatile commodity sectors. In the U.S., COVID-19 restrictions continue to impact our Q1 results. The market environment improved throughout the quarter, including a challenged February, partly due to a significant weather event in Texas, Arkansas, and Louisiana, which have all recovered as we exit the quarter. The weather event impacted our operations but rebounded quickly. With the gradual lifting of restrictions as a result of the increase in vaccinations, the market has been incrementally improving, especially in food service. Outside of foodservice, market conditions were mostly in line with difficult seasonality while remaining strong. Our volumes continue to be robust, and demand from our customers have been outperforming the industry and our expectations. Commodity large bird deboning generated the most improvement, recovering strongly driven by seasonality and significantly better support from food service and exports to some of the strongest markets we've seen in years. We expect the strength in commodities to be sustained beyond Q1 as summer is just around the corner, and chicken demand is historically the strongest during this period. In addition, with more vaccinations, we believe that foodservice demand can return to pre-COVID levels while, at the same time, staffing challenges at our plants will likely lessen as well, allowing us to produce a more optimal and profitable mix of products. We expect to be a major beneficiary of the expected recovery in foodservice demand through our diversified portfolio. We continue to adapt to the changes in channel demand by increasing our volume mix to key customer retailers. Our differentiated offerings along with our key customer model are providing us with better positioning. We're also much better positioned to adjust product and channel mix, thanks to our presence across all sizes from small to large. Our retail volume is expected to improve over the same time last year in Q2. We expect to continue our discussions with customers to better reflect the significant increase in operating costs, including labor and fees as well as the general oversight in supplies. Despite challenging conditions for small birds with traditional foodservice distribution, our demand remains strong, driven by our key customer outperformance within the QSR and retail deli. Online sales are forecasted to grow around 22% over the next five years. We continue to deliver strong online growth of almost 4x the projected category growth number, mainly driven by case-ready and prepared offerings across the Just BARE and finer brands. As of Q1, we posted roughly 85% growth versus last year. We are also gaining more brick-and-mortar retail distribution for our fresh Just BARE brand. Our market leadership in these categories and our differentiated product portfolio have continued to strengthen our competitive advantage over the industry. The expansion of our case-ready capacity at our plant in Hosting, Minnesota is now complete and has almost doubled our mix of more stable margin case revenue products, especially focused on our differentiated high-attribute Just BARE brand. We experienced a much more challenging labor environment in Q1 across U.S. operations. We have rolled out more than $40 million in strategic wage increases for our team members to mitigate the operational challenges and to remain competitive within the market. At the same time, we continue implementing a long-term strategy of introducing more automation to our operations to reduce operational challenges related to labor. In the U.S. prepared food business, our consumer-packaged branded business grew 70% year-over-year, partially offsetting the year-over-year decline in schools and foodservice, which continue to be impacted by the dynamics of the pandemic. In anticipation of the return in demand from these channels, we have been investing in our prepared business to benefit from recovery and are expanding our production in West Virginia. We continue to grow our branded consumer packaged business with more line extensions of our Just BARE products, coupled with renewed commitments on our partner brands. We will diversify our product and channel mix to further stabilize our prepared margins. At the close of Q1, industry inventory continued to decline from its position at the end of Q4. USDA chicken inventory was down 11% from December 2020 to February 2021, and about 17% from the previous year. Combined, our vendor's inventory dropped by 13% from December 2020 and is down 27% year-over-year. The year-over-year improvement in inventory was expected as early 2020 inventories reflected preparation for shipments to China that were initially delayed by the COVID-19 dynamic. Quarterly export numbers have outperformed expectations, even though the protein industry faced some shortages, delays, and worldwide container imbalances. But as of February, the poultry industry grew its exports by 5%, indicative of potential for a more balanced trade portfolio as pandemic recovery efforts continue throughout 2021. Exports to China have continued to grow strongly, and it remains a good destination for us while also having the potential for driving demand in other parts of the future. Due to recovering demand, high feed costs, and a weaker dollar, our exports continued to see growth for 2020 at higher prices. In 2021, we expect similar growth numbers and are committed to expanding and diversifying our portfolio of destinations. Year-to-date, we have added several new direct clients and have continued to introduce our brands to new markets. The biggest hurdle quickly becomes the most significant headwind for the industry in early 2021. We have taken strategic positions very appropriate, and we're confident in our supply chain's ability to execute, prioritizing profitability for our business units. Compared to a very challenged Q1 last year, Mexico had another strong quarter over robust second-half performance in 2020, driven by a balanced supply-demand relationship and continuous improvement in our operational performance. We adapted operations well to generate strong performance, despite volumes in the fresh segment that were below those of 2020. In Q1 of last year, the market was oversupplied, leading to much higher-than-normal average turn rates that contributed to the supply-demand imbalance. More normalized economic activities and increased share of non-commodity products have also contributed to our strength. We expect overall demand to continue to be solid, while we remain agile and continue to adapt our facilities by shifting production to those channels that are experiencing strong demand. Our prepared foods have also rebounded well with strong demand. We maintained our pursuit of our strategy to invest in our brands in both fresh and prepared business, seeking to establish strong differentiated brands and products, while increasing our share in modern channels with more stable margins over time. We expect challenging grain prices and volatility in the U.S. dollar to normalize demand, which should help keep the supply-demand equation fairly balanced in the future. Our team in Mexico continues to relentlessly focus on operational excellence and customer satisfaction, and we remain committed to long-term growth and demand prospects in Mexico. In Q1, our combined European operations continue to capture operational improvements despite significant challenges in feed costs, lower volumes due to lockdowns, export constraints to China, and COVID-19 mitigating costs. Despite materially higher feed costs and COVID-19 mitigating costs of more than $4 million and lower volumes due to pandemic restrictions, our business generated results similar to the prior year. We expect more of our performance to continue to improve in the coming quarters as the sharp increase in feed costs is partially offset in the following quarter through our sales contract models, reflecting the mitigation of higher costs in the sales price. We are already beginning to see demand conditions improve as lockdowns in Europe are lifting. We have maintained the performance of previous U.K. operations with positive EBITDA contribution. During Q1, we experienced a reduction in volume to China due to the suspension of our export licenses at two plants as a result of COVID-19. In addition, pressures in the EU and U.K. were under pressure because of ASF in Germany, despite higher grain costs. However, operations are already starting to recover. Our business is more integrated than the competition, which aided our performance during the quarter with lower prices of live animals. Overall, we believe that over the long term, this remains a strategic advantage. The integration of operations remains on track. Over the next few years, we expect to generate improvements to achieve a level that competes with leading companies that have similar portfolios. We have expanded our distribution capabilities for the previous U.K. assets through recent developments to increase our retail exposure and strengthen our partnership with key customers. Our key customer strategy is working well as expected and has increased our volume by 7% in Q1 to those customers. In Q4 of last year, our brand-new refurbished site in Danboro became fully operational for our retail packing business. We have invested in state-of-the-art food manufacturing technology with high levels of automation to serve our key customers while de-emphasizing the proportion of commodity sales. Value-added products will present opportunities for further growth and expansion in the future. We remain optimistic about building upon our operational improvements by continuing to optimize our manufacturing footprint and extracting best-in-class operational excellence along with expert opportunities, optimizing the portfolio of channels, segments, and products while strengthening our growth with key customers to drive innovation in value-added and high-margin areas. The combination of increasing demand and lower production has provided the catalyst for a price rally this year. In their May supply-demand estimates, USDA projects U.S. corn ending stocks at 1.35 billion bushels, a decrease from last year's 1.9 billion. Exports are projected at 2.7 billion bushels, up from last year's 1.8 billion, driven primarily by increased exports to China. In addition to higher export demand from China, there is full selling in the market now that Brazil's second crop is not getting enough rain, which is creating more risk premium in the market. USDA reported that farmers intended to produce 91.1 million acres, which was considered less than we and the market had expected. However, we believe the actual acreage for corn will eventually turn out higher due to the recent increase in new crop prices and favorable weather forecasts for planting. High wheat prices in Europe have also recently risen following the rally in global corn markets. With rising prices, we expect to see wheat starting to enter feeding rations globally. Overall, we feel good about the U.S. wheat outlook for Q1 21 as live weight production decreased by 3.4% year-over-year due to fewer headcount.

Matthew Galvanoni, CFO

Thank you, Fabio. Good morning, everyone. First, I want to say I look forward to working with all of you in the future, and that I'm very excited about this opportunity to share our results. For the first quarter of 2021, net revenues were $3.27 billion versus $3.07 billion from a year ago, with an adjusted EBITDA of $254 million or a 7.8% margin, compared to $166 million or a 5% margin from the year prior. GAAP net income was $100 million versus $67 million a year prior. Operating margins were 3.4% in the U.S., 19% in Mexico, and 1.2% in Europe. Our adjusted EBITDA in the U.S. during Q1 was $131 million versus $137 million a year ago. Although the markets across our fresh business units were generally better compared to last year, the direct result of indirect costs related to COVID-19 mitigation drove higher operating costs. The significant increase in grain costs late in the fourth quarter and through the first quarter pressured U.S. earnings during this period. We continued to pass through these increases, but often on a lag. Our case-ready and QSR businesses remained strong, while the market for large bird deboning rebounded due to an improvement in demand from food service. We expect the strength in the commodity sector to be sustained as we enter the summer grilling season, when demand traditionally is strong, alongside fewer COVID-19 restrictions and the further rollout of vaccinations driving continued recovery in foodservice. In Mexico, we achieved a significant improvement compared to last year, with $86 million of adjusted EBITDA versus a loss of $17 million in the prior year. The supply-demand balance remains favorable since the second half of 2020. Chicken prices, especially in traditional markets, continue to be at a high level, well above the last three years. Our prepared foods in Mexico continue leading market development, and we are on pace to launch numerous new products this year. In Europe during Q1, we generated approximately $37 million in adjusted EBITDA versus $45 million last year. The performance for our legacy European operations was impacted by higher feed costs and COVID-19 related effects on both year-over-year volumes and costs. Despite these difficult conditions, we expect performance to recover in the coming quarters as costs start to stabilize while sales prices reflect the reduced COVID-19 expenses. Our SG&A expenses during the first quarter were slightly higher compared to a year ago due to increased legal costs and our further support to expand the Just BARE brand nationally. We will continue prioritizing our capital spending plans this year to optimize our product mix aimed at improving our ability to supply innovative products and strengthen partnerships with key customers. We reiterate our commitment to invest in strong growth projects that will enhance operational efficiencies and meet customer needs, solidifying competitive advantages for Pilgrim's. Our balance sheet continues to be robust, given a relentless emphasis on cash flows from operating activities and focus on management of working capital and investments in high-return projects. Our liquidity position remains very strong, with more than $1.2 billion in total cash and available credit. We have no short-term immediate cash requirements, with our bonds maturing in 2027 and newly issued lease bonds expiring in 2031, as well as a term loan in 2023. At the end of the quarter, our net debt was $1.9 million, with a leverage ratio of 2.2x the last 12 months of EBITDA. Our leverage remains at an manageable level, and we expect to produce positive cash flow this year, bolstering our financial capability for strategic actions. Excluding the debt distribution and costs recorded in the second quarter, we anticipate 2021 interest expense to be lower at around $115 million to $120 million as a result of the new sustainability-linked bond issues. We remain focused on ensuring that we maximize shareholder value by optimizing our capital structure while preserving flexibility to pursue our growth strategy, and we will continue to pursue capital allocation strategies that align with our value-creating standards. Operator, this concludes our prepared remarks. Please open the call for questions.

Operator, Operator

The first question comes from Ben Theurer from Barclays.

Benjamin Theurer, Analyst

Matt, congrats on the results. Very, very strong first quarter here. Two quick ones. So first, obviously, the strength in Mexico this quarter was particularly surprising, and it was even stronger than in the fourth quarter. How sustainable do you think this very high level is? Or at what point will the more informal players come back into the market and potentially create an imbalance in what is currently a balanced supply-demand side? If you could elaborate a little bit on what you are seeing on the ground, that would be much appreciated. And then I have a second one.

Fabio Sandri, President and CEO

Sure. As we always discuss, Mexico can be quite volatile quarter-over-quarter given the market conditions. However, over the year, results have been consistent. Last year was no different; we experienced extreme volatility during the quarters but ultimately finished in line with previous years. The supply-demand situation in Mexico has been a bit out of balance; there’s a reduction in supply due to high feed costs creating some uncertainty. As mobility in Mexico increases and demand improves, the imbalance between supply and demand has created higher prices that began in Q4 and have continued throughout Q1 and onwards. What can change is as the market stabilizes and we see more mobility, I believe that these smaller players, and even some bigger players, will likely start increasing production to create more stability in supply-demand. It's important that we've been growing our portfolio there; we continue to invest in the country, with plans to build a new complex in the South region to support growth in Mexico in the coming years.

Benjamin Theurer, Analyst

Perfect. And then my second question is regarding the current pricing environment and your results in the U.S. Can you provide some sequential data points on how things transitioned from January into March and what you're observing in April in terms of profitability? We all know that prices are high, but costs are too, and I want to understand how the second quarter is shaping up and expected profitability during the summer period.

Fabio Sandri, President and CEO

Certainly. We saw a continuous increase in profitability from January to February and into March. February was impacted by the winter storm, which affected operations and volumes, but we have had a rapid increase in profitability from January through March, and now into April. Our differentiated portfolio protects us from the downside while allowing us to capitalize on upside in the market. Many parts of our portfolio are tied to market conditions, where around 15% can be adjusted based on grain costs, which positions us favorably now as we negotiate with key customers on these conditions.

Benjamin Theurer, Analyst

Perfect. And for the second quarter, you believe it will be significantly stronger year-on-year and sequentially, correct?

Fabio Sandri, President and CEO

As we observed last year, Q2 was heavily impacted by the COVID situation. So this should provide a favorable comparison. From what we're seeing, the month-over-month increase so far this year has been significant. Historical grilling season gives us the strongest time for all proteins, and chicken continues to be the most affordable protein both domestically and for export markets.

Benjamin Bienvenu, Analyst

You've made some comments about labor in your prepared remarks. I know that's been a source of supply constraint in the industry. I'd like to get a sense of how that's progressing and how impactful stimulus-related payments are in terms of labor availability. Moreover, how do you see labor availability trends throughout the year?

Fabio Sandri, President and CEO

Yes, that’s a pressing issue impacting our industry and many others. We have experienced labor shortages due to a mix of stimulus payments, tax refunds, and unemployment benefits. The labor market today is tighter than it was even at full employment. We have continued considering all options and are aggressively addressing the situation with strategies that examine individual plants and labor needs specific to regions. We have invested over $40 million in salary increases this year to attract and retain skilled team members.

Benjamin Bienvenu, Analyst

Okay, that's very helpful. My second question relates to the European business. Feed costs are rising as you've noted. Can you discuss any emerging trends regarding exports to China, and also your ability to pass along price increases to catch up on higher feed costs? How should we think about margins trending in this area for the remainder of the year?

Fabio Sandri, President and CEO

Yes, that's right. Our feed cost models do include pricing mechanisms that incorporate feed cost increases; however, there is typically a lag of about 3 to 6 months before adjustments take effect. The rapid increase in feed costs has put pressure on our margins, but we expect to reclaim those margins over time. We're also looking forward to the resumption of our export licenses to China, which will help improve margins further. We expect that as we begin to see prices stabilize and markets open up, we can expect a positive shift in our overall performance as well. The regulatory dynamics and market situations allow for passing along necessary costs, but they do take time to balance out. We're optimistic about the long-term growth projections for export markets, particularly to China, and we feel confident that with the right strategy and execution, we are well-positioned to benefit from these growth opportunities.

Michael Piken, Analyst

I want to touch on the feed cost situation and how you're managing that. Have you locked in any pricing for your feed, or are you purchasing mainly on the open market right now?

Fabio Sandri, President and CEO

Yes, we have observed price increases as the market has grown more concerned about the availability of U.S. supplies. We've been actively managing risks by adjusting positions depending on our market outlook, and we do not follow a fixed strategy for hedging. Currently, we believe the position we have is appropriate given market risks.

Michael Piken, Analyst

Thanks for that. My second question concerns the interplay between the resurgence of food service and its potential adverse effects on your retail or fast-food business. Are there any certain channels that seem more favorable to you as food service strengthens?

Fabio Sandri, President and CEO

That's a great point. Our current portfolio provides us with a strong hedge as we are well-diversified, with an even split between food service and retail. We increased our retail exposure last year during food service's decline, but we foresee a return to balance in 2021 as restrictions ease and food service rebounds. As of March, our food service segment has surpassed sales volume from March 2019, driven by QSR growth and resurgence in full-service restaurants. We are confident that as food service demand increases, chicken consumption will rise, especially considering the ongoing popularity of chicken sandwiches and the higher frequency of chicken-oriented meals being ordered. The overall growth in food service should not significantly detract from retail, leading to a favorable situation for us.

Peter Galbo, Analyst

I want to clarify a couple of points. First, in response to Ben Theurer's earlier question, you mentioned that about 15% of your portfolio ties to cost-plus contracts. Could you update us on the exposure tied to UV contracts? What is the specific percentage?

Fabio Sandri, President and CEO

The 15% of contracts is tied specifically to our cost-plus agreements, while our UV exposure primarily relates to our size within big bird operations, constituting about a third of our fresh operations. These dynamics push us towards better price realization strategies to adapt to changing market factors.

Peter Galbo, Analyst

Got it. That clarification helps. Regarding small bird profitability, is that primarily due to feed cost challenges, or are there additional factors? Can you provide insight on profitability across large, small, and medium birds?

Fabio Sandri, President and CEO

Small bird profitability has been influenced largely by retail deli sales, as foot traffic has not matched pre-pandemic levels. Despite strong retail demand, deli sales have been down, which has impacted our small bird operations significantly. Conversely, QSR demand remains robust, helping counterbalance some of that. Profitability-wise, we observe higher margins in the commodity segment compared to small and medium birds, with price realization lagging behind feed price increases. The pricing realization impacts all segments whereas commodity markets have recently increased, leading to small delays in fresh realization. As we renegotiate contracts, the price pressures will help bring profitability back to expected levels.

Adam Samuelson, Analyst

Continuing from Peter’s line of questioning, could you guide us on non-feed inflation impacts year-over-year related to COVID costs? I know Q1 still presents a negative year-on-year outcome, yet should improve as you work through previous impacts.

Fabio Sandri, President and CEO

The primary non-feed cost increases have been labor-related, as we allocated $40 million in salary increases to attract necessary talent. Some inflation exists in utilities and packaging but is more localized and manageable. We're working diligently to mitigate these increases through operational improvements while enhancing productivity and yielding more from our operations.

Adam Samuelson, Analyst

Thanks, Fabio. Could you give us an example of how your portfolio diversity has presented a major advantage during the recent months of COVID disruption?

Fabio Sandri, President and CEO

Certainly. One example lies in the way we increased our retail operation by 3-4% as food service declined. We shifted small bird production from deli formats to QSR segments, allowing for higher demand fulfillment. We've also utilized internal meat sources to support the prepared food sector as we pivoted production across our categories to adapt to market conditions swiftly. Our strategy has allowed us to maintain a degree of stability and mitigate downturn scenarios, showcasing the effectiveness of our diversified portfolio.

Operator, Operator

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back to Fabio Sandri for closing remarks.

Fabio Sandri, President and CEO

Thank you all. We would like to reiterate our continued commitment to our valued team members to provide them with a safe and healthy work environment while supporting our duty to maintain food production and supply to customers. We're looking forward to an exciting 2021 and expect better results despite volatility. Our diverse portfolio of differentiated products continues to support our key customer strategy in conjunction with our broad geographic footprint. We will continue to generate consistent performance in minimizing margin volatility in challenging market conditions relative to competitors. We will seek new growth potential organically and through acquisitions while offering even more differentiated products within our business that supports key customer needs and fosters a culture of relentless innovation. Thank you for your interest in our company.

Operator, Operator

Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.