Edited Transcript of ING.AX earnings conference call or presentation 20-Feb-20 10:30pm GMT

NORTH RYDE Jun 5, 2020 (Thomson StreetEvents) — Edited Transcript of Inghams Group Ltd earnings conference call or presentation Thursday, February 20, 2020 at 10:30:00pm GMT

* James B. Leighton

Citigroup Inc, Research Division – MD, Director of Research for Australia & New Zealand and Lead Australian Consumer Sector Analyst

Evans & Partners Pty. Ltd., Research Division – Executive Director of Consumer

Ladies and gentlemen, thank you for standing by, and welcome to the Inghams Group First Half 2020 Financial Results Conference Call. (Operator Instructions) Please be advised that today’s conference call is being recorded, Friday, 21st of February 2020.

And now I’d like to hand the conference over to your speaker today, CEO and Managing Director, Mr. Jim Leighton. Thank you. Please go ahead.

James B. Leighton, Inghams Group Limited – MD, CEO & Director [2]

Thank you, operator, and welcome to Inghams first half 2020 result call. With me, I have Gary Mallett, our CFO; Jonathan Gray, our New Zealand CEO, and Craig Haskins, who is our Investor Relations Director.

I’m pleased to report that our operating result, that is underlying EBITDA before the impact of AASB 16, of $91.7 million is in line with our expectations. You are all aware of the issues that we spoke of at the full year results and the operational and financial headwinds that we experienced as we exited the second half of FY ’19. We described, in some detail, the impact on our earnings that would carry through to the first half of FY ’20 as we fixed the performance of our further processing network following what was a poorly executed restructure and a number of other associated issues.

As anticipated, the hard work and changes have now resolved the issues, and our business momentum has improved throughout the second quarter. Our FP volumes have significantly improved. Costs are under control, and importantly, we are delivering far better customer service, which have had a positive impact to our mix, but wheat, our largest commodity input, continued to trade at close to historic highs. Our New Zealand business, as Jonathan will talk about in a moment, is well on track and turnaround plan has delivered strong year-on-year growth. This performance was achieved despite the headwind of market oversupply that resulted from the outbreak of infectious bursal disease virus, IBDV, which closed New Zealand market to poultry exports to 4 countries, including Australia. Core poultry volumes across the business, that is chicken and turkey volumes that we sell for human consumption, are up 4.1% on year. This reflects the attractiveness to consumers of poultry versus other proteins and, pleasingly, the success of our key customers in growing their volumes.

As we talked about at strategy day in October, we have now shifted our focus to be more strategic with our customers, and some of that benefit is starting to emerge. There’s significant upside in supplying the right products through the right channels and at the right price, and we have constructive discussions with our customers around mitigation of feed input costs.

Australia volumes were up strongly, 4.7%, but as expected, New Zealand grew only 0.9%. Feed costs remain at close to all-time highs as the actual result of the 2019 wheat crop fell well below earlier expectations. You recall, at the strategy day, we talked about a crop expectation of 17.5 million tonnes, and it looks like it has finished somewhere below 15 million tonnes, one of the worst 3 years in the last 2 decades. But despite this, our feed cost was broadly within our anticipated range. At our strategy day, we talked about our 5-year plan for growth, and we introduced you to the leaders who are steering that growth and change throughout the business. It is a quality and a coordinated team. The team is working hard to move the business forward and the results are favorable, but there is still much work to do. There always is in poultry, given the complexity of the integrated supply chain that I hope you are all now coming to better understand.

I will leave a broader discussion of our financial results to Gary, but a few obvious callouts. Our statutory accounts reflect the full adoption of AASB 16, and this is not new news, but given the magnitude of the asset and liability that is recognized, some $1.6 billion, and the related impact on reported profits and EBITDA, it is worth making a number of comments. Our portfolio of leased property assets is well understood. We bring about $800 million of assets and lease liabilities onto our balance sheet. Our grower contracts are also captured under the standard, and we recognize approximately $700 million of assets onto the balance sheet. As I have said, our growers are key stakeholders in our business, and we work closely with them to support them. The third-party grower model is an industry standard and the contracts give security to the grower and to us.

We all strive for the same outcome, best welfare, animal health and growth. You can see the impact of the standard EBITDA to profits in our statutory accounts, and Gary will reconcile a lot of that in a few minutes. The cash conversion at an operating level is 60%. This is about in line with where we thought it would be, given our early close to the books on December 28. And Gary will go into more detail, but what I meant was that we didn’t collect some cash on our strong December sales until later. Some $44 million was collected after our books closed, but prior to 31 December. We spent $40 million on CapEx during the half, including our HatchCare hatchery projects, the spin chillers in Victoria and WA and our newest breast deboner in New Zealand.

Cash conversion is always a focus in our business. So there is no underlying issue here that we or you should be concerned about. We have indicated that our debt may rise with capital invested at $323 million, and it is well manageable within our leverage of 1.7x. Our business has had to overcome some dislocations and disruptions with the bushfires. Whilst that obviously occurred prior and after the half, I can report that our business has been resilient, and our team have managed through this to service our customers and deliver against expectations. Prior to Christmas, our growers and employees at our turkey and chicken assets in [Fargo] and Tahmoor were in the eye of the bushfires. Our bushfire plan was flawlessly executed, including evacuating our Tahmoor plant and well sustained — we sustained zero loss to harm — to our people or our facilities.

We had to deal with an issue in Perth being cut off to road and rail in the week leading up to Christmas, and we worked hard to make sure that our valued customers there had stock in their stores to feed a hungry public. In their business, no chicken, no business. The major dislocation of people from the coastal communities for both residents and tourists created challenges to the supply chain and also planned demand patterns. I’m very proud of the Inghams team for going above and beyond to make sure that our customers were looked after and the consumers could find our products where and when they needed them.

Turning to our strategy update on Slide 6. We are well progressed with the implementation of our strategy. As I said in October, the objective of all the work that we are undertaking is to increase the performance of the business and to reduce volatility, where we can deliver more consistent, predictable and reliable growth. The 3 pillars of our strategic framework that we shared with you are on this page. Optimize the core, innovate to grow and to invest in the new. They are all interrelated and the protein markets are evolving. So we need to ensure that we are fit to be able to take advantage of the opportunities that we see today and into the future. Our new operations team, they’re after it. Our newly created continuous improvement team are adopting a quantitative and qualitative framework in measuring operations, and we can see the runway to improvement.

Our farming team is on the path to improvement. We have made changes to our nutrition team, are now leveraging more global best practices, been working more collaboratively with the feed team, whose job it is to procure feed ingredients and formulate at the best possible cost, performance and conversion. Our sales and marketing teams are thinking strategically, and we have had productive dialogue with many of our customers. We will partner to grow the poultry category and help our customers deliver great products to consumers. But what we won’t be are all things to all people.

We have installed a new chilling system at Somerville in Victoria, which has led to the debottlenecking of that plant and allowed expansion of production capacity in Perth, which is next. We also installed a new deboner in New Zealand, and our new hatchery projects are well underway. We’ve talked about the capacity unlock from modest CapEx, but we are very mindful of balancing that capacity growth with demand as we see it. It is up to us to see the opportunities and create new growth as well as through innovation, and that is exactly what we’re doing.

Our new product development process is now fully integrated, where the whole supply chain is involved. We are targeting profitable and importantly, accretive growth. We have an exciting pipeline of new products and innovations, some of which are very close to market launch. Our new research farm is now operational. And as I mentioned, it is a key enabler to optimize breed, feed and conversion.

The HatchCare technology we are deploying is world-leading for animal welfare. It will promote better growth outcomes for our birds as well as more animal welfare and reduced live costs. We are in the first half of our turnaround and new strategy with a new team. We are all enthusiastic and working very productively. But our first priority every day is on delivering consistent service, product, quality, welfare, safety and efficiently and profitability. On safety, it is mine and the team’s priority every day, every — absolutely every day to ensure that every one of our people operate in a safe environment and go home to their families every night and in as good a condition as when they arrive.

We had an accident in one of our facilities this week, and that one accident is one too many. We are well positioned to execute on what I call adjacent protein strategies. There’s been much work going on in the background, and we’ll get going on them. When we are confident we can deliver accretive growth by investing in the new. Since Gary’s arrival, he’s been busy reviewing our capital plan and balance sheet. We intend to remain conservative and give ourselves headroom for future growth projects. Projects and network optimization, innovation are ongoing, and we will be prudent in our capital management as well as allocation.

I will now hand it over to Gary to review the financial results in more detail.

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Gary Mallett, Inghams Group Limited – CFO [3]

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Thanks, Jim, and good morning all. Slide 8 is our statutory P&L, and it shows an NPAT of $26.2 million. You can see the major impact that the adoption of AASB 16 has had on our financials. EBITDA has increased by $118 million as lease expenses are removed, but offset by a depreciation expense of $105 million, an interest charge of $31 million and a tax effect of $5 million. This results in a net decrease in NPAT of $12.8 million for the half. And as you are aware, this has absolutely no cash impact on the business.

In line with the accounting standards, we have not restated first half numbers to reflect the adoption of AASB 16. So period-on-period comparisons are difficult. You will recall that in the prior corresponding period, we also had a significant positive P&L impact from the sale of the Mitavite business and other asset sales.

Slide 9 gives you the reconciliation of the half prior to the — reconciliation of half to the prior corresponding period on an underlying pre-AASB 16 basis, which is a comparable way that we look at our business. Underlying EBITDA pre-AASB 16 was $92 million. The reconciliation takes out the $118 million impact of the leasing standard and modest adjustments for a loss on the sale of some small farms, an impairment of the Pakenham hatchery, which we have demolished and are currently rebuilding. The prior period excluded the large gains on asset sales and other significant restructuring costs and the trading of Mitavite prior to the sale. Underlying impact pre-AASB 16 is $42 million, down $13 million on the prior period as further explained on Slide 10.

Jim had talked about our 4% core poultry growth and noted our third-party feed business is essentially flat. Revenue reflects a stable pricing environment in Australia, increases in New Zealand and increases in the prices of third-party feed sales as we pass on higher input costs. We’re also seeing some benefit of the higher value in sales of what we call byproducts, paws, for example. Depreciation is up, in line with our capital plan, and finance expense reflects lower interest rates. As expected, our tax rate of 29% and is in line with our prior corresponding half. Clearly, our profits are down, and that is attributable to the factors that you are well aware of, that have been impacted at unit costs, like throughput and FP, feed costs, lower bird weights and yields in the half in Australia, offset somewhat by improvements in the New Zealand business.

On the balance sheet on Slide 11. This also reflects the significant impact of the new lease standard, with the amounts recognized for both land and buildings and our grower contracts. The land and building component is well understood, and we have an average term of 13 years. Our grower contracts require some explanation. Our growers are key partners in our supply chain, and you will see that we have recorded $700 million as the value of these contracts as both the right-of-use asset and lease liability at balanced [today]. Our grower contracts have an average remaining term of almost 5 years. We supply the day-old chicks, the feed to the growers, and we collect the birds from the sheds when ready for processing. We pay our growers for their services and under the test applied in the standard capture this as a lease of shedding space, and we, therefore, recognize on balance sheet. The variable component of the grower payments are a small proportion and are not captured by this standard.

Looking at cash flow on Slide 12. The main point I want to get across here is that our underlying cash conversion of 60% is impacted by the seasonal working capital build and the early close of our books on 28 December. We are a highly generative cash business, and I can add that we collected a further $44 million of cash on 30 and 31 December. Some may also report that the conversion rate was about the same as the prior corresponding period after adjusting for the cash benefit of the increase to the inventory procurement trade payable taken up in the New Zealand business.

Our CapEx for the half was $40.5 million, which included $17 million on our hatchery projects and other CapEx that has or will increase capacity and performance such as the spin chillers and the new deboner in New Zealand and usual levels of replacement capital.

Turning to Slide 13. We highlight our net debt increased by almost $60 million. Our leverage is now at 1.7x, which is quite comfortable. Debt has increased through higher seasonal working capital, the CapEx program and the absence of major asset sales in the half. We currently have no plans to enter into sale and leaseback facility on our hatcheries, and the spend on these will increase in the second half. We have given you details on our inventory procurement trade payable, which closed at $98 million, and is basically the same level as June ’19. To be clear, this is very common in our industry, is not a factoring transaction nor does it disadvantage our suppliers of commodities in any way. A dividend of $0.073 per share is based on 65% of underlying NPAT pre-AASB 16, and for clarity, our policy remains unchanged that will pay 60% to 70% of annual underlying NPAT per AASB 16.

And just as a final point, Jim will cover outlook later on, but we haven’t given guidance in this half. We’re happy with the comments that we’ve made, both on the strategy day and the full year. And our message is we’re trading on track.

Back to you, Jim.

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [4]

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Thanks, Gary. Looking at the performance of Australia in the half on Slide 15. We have talked about good volume growth in core poultry. And if you adjust for the sale of Mitavite in the prior year, feed volumes are up modestly. You can see that the margin was significantly impacted by all the factors that we’ve talked about. But as I noted earlier, the run rate of the business has improved throughout the half. Our retail channel is solid. Pricing has stabilized, and our key customers performed well. QSR, which, as we talked about at the full year, continues to show growth as promotional activity and good execution drive sales. We have talked about the issues that we faced regarding our arrangements with some of these customers, and we are moving in the right direction.

The fallout from IBDV, the issue in New Zealand and Australia, saw us capture some of those volumes that were previously imported. Delivery to our foodservice customers improved as we started out the FP issues that negatively impacted our volumes and created the negative mix impact that we’ve talked about. Export is in its early stages, but we have established markets now and the opportunities for byproducts, such as the harvest and sale of chicken feet. Also, we are seeing broader opportunities to partner with some customers to supply further processed products into the Asian markets, but it’s early in its days.

I will now hand over to Jonathan to talk you through what was a very, very pleasing result in New Zealand.

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Jonathan Gray, Inghams Group Limited – CEO of New Zealand [5]

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Okay. Thanks, Jim, and good morning, everyone. From a New Zealand perspective, we are pleased with the progress we’re making in our turnaround plan. And just as we said we would, we are now delivering year-on-year growth. The $3.4 million improvement in underlying EBITDA, that’s pre-AASB 16, to $17.6 million represents an improvement of 24% compared to the corresponding period last year. I’d just like to acknowledge the fantastic contribution from our entire team. And while we still have plenty of work ahead, we’re all energized to capture the latent potential in the business.

As we look at volume, growth was impacted by the rebalancing of the market as the IBDV issue, that Jim referenced earlier, saw our competitors clear excess stock domestically. The resulting oversupply and market rebalancing is still ongoing. However, despite this, we were able to secure some price rises through the first half in key channels to help partially offset high feed prices. And this, together with product and channel mix improvements, saw our revenue grow nicely.

Our focus on operational excellence is delivering positive results. We brought our broiler farming capacity back to where it needs to be, and we are a more balanced business than we were previously. Sales and marketing are aligned with operations across both primary and further processing. In safety, quality and animal welfare, which are the key pillars of what we do every day, I’m proud to advise that positive trends have been recorded in each of these key areas also, which is accretive again to our leadership teams and to all of our people.

Our external feed business remains impacted by favorable growing conditions for dairy in the half, and volumes were down, as you can see. Once again, I’m pleased to report that we are delivering to plan and have returned to year-on-year growth.

Thanks, and back to you, Jim.

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [6]

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Thanks, Jon, and what a great effort by you and all of the team facing some pretty interesting short-term challenges over there.

Looking now at the feed markets on Slide 18, to reiterate what I said in my opening remarks, when we talked to you in October, the outlook for 2019, the drought-affected wheat crop was forecasted to be lower than 2018 with wheat prices reflecting the uncertainty and stock shortages. You’ll recall that last year, Australia domestic wheat used was supplied from WA. This year, SA and Victoria had stronger wheat crops, whilst, once again, New South Wales and Queensland suffered the brunt of the drought. For Inghams having access to wheat stocks in the regions where we have facilities is extremely helpful. However, we still need to import grain into our facilities in New South Wales and Queensland. This map provides a view of this year’s crop versus last year’s. The sorghum crops in Australia have also impacted us by drought.

The lack of rainfall in the sorghum-growing regions prior to Christmas will result in a small crop with delayed harvesting. As a result of the drought conditions, grain prices remain high. As such, the entire poultry and other ag industries are facing the same challenges for another year. We are a physical buyer of grain for delivery into our feed mills in the various states in which we operate. Our procurement strategy is flexible to take account of market conditions. The recent rainfall has been welcomed by all farmers, and we have seen more encouraging grower selling, but the impact of the next harvest is still too early to call and will largely be based on continued rainfall and no adverse weather events.

Now turning to our outlook for the rest of the year on Slide 20. We continue to see poultry as the most competitive protein, and we expect to continue growth — we expect continued growth in the category. Our 5-year strategic plan is now well embedded into our business. Our continuous improvement team and project teams are now established and building the foundations for our growth. There are multiple work streams and the intensity of activity is high. We are critically evaluating performance across operations, sales and marketing, and we are asking for a high standard.

Culture is critical to success, and I am very passionate that we have a culture that is open, honest and collaborative, and that applies internally as well as externally. So we’re having some hard conversations that needed to be had. We want to be successful, and we will partner with customers who want to grow with us. Internally, we are asking much of our people and this brings change, which is a good thing. And as I’ve said, poultry is complex and requires real attention to detail. Our team is energized and around the opportunity for the future.

As I noted, the exit rate from the half in Australia was encouraging, but there remains a lot of work to do operationally, like all consumer companies, we are closely monitoring the impact of bushfires, recent weather events and health issues on our consumers as well as our customers.

Our New Zealand’s turnaround is well on track with continued momentum. We anticipate the market will remain closed to exports to Australia and the timeframe is unclear at this stage as to when that might change. In the meantime, we continue to see supply rebalancing.

Feed cost is elevated, and we are working with customers to ensure that we collaborate to mitigate this and other costs where we can and, of course, we’re focused on operational improvements which help us offset this impact as well.

And finally, I want to thank all of the Inghams team for their hard work in the half and ongoing and our customers and those of you who support our business.

And with that, operator, I’ll turn it back to you for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have multiple questions in queue. Our first question is from Mr. Craig Woolford from Citigroup.

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Craig John Woolford, Citigroup Inc, Research Division – MD, Director of Research for Australia & New Zealand and Lead Australian Consumer Sector Analyst [2]

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Just wanted to understand the pricing realized in Australia. There’s a bit of work to do to get to an underlying number, but it looks like it was broadly flat, it was 0.2 was my calculation on core poultry pricing growth, which is a step down from the June half run rate. So I’m just interested in what drove the low level of pricing growth. And yes, I’m a little bit surprised, given that there was still, obviously, some feed cost pressures that you’re trying to mitigate.

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [3]

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Yes, Craig, it was basically the way to think about it was flat first half to last year. And obviously, the things that impact that are things such as mix and so forth. But yes, we think of it as basically flat.

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Craig John Woolford, Citigroup Inc, Research Division – MD, Director of Research for Australia & New Zealand and Lead Australian Consumer Sector Analyst [4]

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Is that because you chose not to put any price rises through?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [5]

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Well, it’s a variety of different things. Again, a lot of it has to do with mix, a lot of it has to do with channel. And we basically did not put a lot of price in place in the first half of this year. Yes.

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Craig John Woolford, Citigroup Inc, Research Division – MD, Director of Research for Australia & New Zealand and Lead Australian Consumer Sector Analyst [6]

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Okay. Understood. And my second question, at the Investor Day, there was talk about a capital management plan, which is still being developed. I don’t see anything formally presented that way in the results here. Is there going to be a formal disclosure what the capital management plan is? Or is it just sort of weaved into the commentary you made as part of this presentation?

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Gary Mallett, Inghams Group Limited – CFO [7]

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Craig, it’s Gary. I think — I don’t think we’ll have a formal one, but it is weaved in. I can make a few comments now, if that would be helpful. But certainly, I have been reviewing our capital plan, also our appraisals for allocation, ask lots of questions and ensuring all of our proposals are robust. The good news is there is money to spend in Inghams on growth maintenance and improving operations. We are considering the cost of funds, e.g., funding the hatcheries from balance sheet is our current thought on the basis that the cost of funding is much lower. We’re reviewing the remaining noncore assets that we have. We’ve been clear on dividend payout expectations.

And from a slightly look forward position from my comments, we’re spending more in the hatcheries in the second half. We’ve got spends around our chiller in WA. We’ve also got a chiller into our turkey operation. We’re investing in our New Zealand FP plant in Auckland and a fully cooked line. So we’ll see a rise in CapEx in the second half. But that will be offset somewhat or mainly by an improvement in working capital. So we expect leverage would be about the same. I think we’ve got some headroom in leverage that we could go up a bit more, maybe up to 2%, but that would be broadly how we’re thinking about it.

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Craig John Woolford, Citigroup Inc, Research Division – MD, Director of Research for Australia & New Zealand and Lead Australian Consumer Sector Analyst [8]

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Yes. So just to clarify, I think the capital management plan is quite important because Jim had highlighted that the company would like to have CapEx in line with depreciation. But just want to get a feel for, is that where you see things through the cycle?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [9]

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Yes, Craig, this is Jim again. Again, we are 6 months into a 5-year plan. So my comments regarding where we would be is when we get to more of a business as usual. And we have, as Gary had mentioned, a number of continued major projects that are taking place right now that will be completed over the next year or 2 years.

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Operator [10]

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Our next question in queue is from Michael Peet from Goldman Sachs.

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Michael Peet, Goldman Sachs Group Inc., Research Division – Executive Director [11]

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Just firstly, on the feed cost side, just wondering whether the summer crop and any of the recent rains sort of helps a little bit. And just how much visibility have you got and how much sort of forward buying do you have at the moment?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [12]

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Michael, great question. Obviously, with the recent rains, I think there could be some speculation that feed costs will come down. However, as we’ve stated and we’ve been consistent in stating, we take physical positions at somewhere between 3 and 9 months and seeing that the rain is happening when it’s happening has really — has not and will not have an impact until we see what the impact of that new crop is. So the only influence it would have is relative to people — farmers who have inventory in the bins, and then it’s up to them to decide when or if they’re going to sell it now or later.

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Michael Peet, Goldman Sachs Group Inc., Research Division – Executive Director [13]

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Okay. And just on New Zealand, obviously, they held up very well, particularly on the margin. Have we — are we sort of through the worst there? And can you hold that margin going forward in New Zealand, do you think?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [14]

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Yes. So I’ll let Jonathan weigh-in on this, but I do want it because it’s been an opportunity for me to say this, as Jonathan has been in New Zealand just over a year, and he has done an — he and his team have done an excellent job basically delivering against what we set forth to do, and I couldn’t be more pleased with the results. Jonathan?

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Jonathan Gray, Inghams Group Limited – CEO of New Zealand [15]

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Yes. Thanks, chairman. And thanks for the question, Michael. Through the half, we had a combination of price increases. And also, importantly, some improvements in both channel and product mix. And we see that remaining as key focuses for us through the period.

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Michael Peet, Goldman Sachs Group Inc., Research Division – Executive Director [16]

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Okay. And just a question on Australia. I mean, obviously, disruption there with the pay issues and cost overruns that have been well disclosed. But how are we looking — are you still encountering those issues in the second half? Or when do we sort of cycle out of those?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [17]

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Yes. As we stated, the momentum that we saw throughout the first half from exiting the second half last year into the first half of this year is basically right where we thought it would be. So we’re very comfortable with what we said at the full year.

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Operator [18]

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Telephone question in queue, is from Matt Johnston from Macquarie.

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Matthew Johnston, Macquarie Research – Analyst [19]

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Maybe just first one, just on the feed again. Could you just maybe comment about what the growers are doing on inventory? And what that means when you go to forward cover? Does that mean a realized price at spot or above or below?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [20]

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Yes. So we — as I believe I mentioned in my comments, we’re a physical buyer of grain and procure that grain then is shipped to our feed mills and converted to feed that obviously go to the sheds to feed the chickens. And so we typically go out 3 to 9 months. And for a variety of reasons, we don’t state how far or short we are at any particular time. So yes, I don’t know if that answers your question, but that’s our procurement strategy.

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Matthew Johnston, Macquarie Research – Analyst [21]

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Okay. Great. And then just talking around the CapEx and sort of guiding some of those operating efficiencies you talked to before. Could you give a bit more clarity around what sort of efficiency timing, do you expect it to pick up in the second half or is it more FY ’21 and beyond story?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [22]

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Yes. So the operational improvements that we talked about, both in strategy and full year, I’ve been out to the facilities, and I’ve seen the progress, but it’s going to be mostly towards FY ’21. But we have already unlocked some additional capacity. But of course, we only utilize that capacity as demand requires, and we’re only going to fill that capacity with volume that it makes sense for us to do so, so ’21.

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Operator [23]

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Our next telephone question is from Paul Buys from Crédit Suisse.

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Paul Buys, Crédit Suisse AG, Research Division – Head of Research and Director [24]

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Just firstly, a follow-up question on New Zealand, please. Just — I mean, clearly, an impressive performance. I just wanted to get maybe a little bit more color, if I could, just as to exactly how you got those price increases through, given the environment, as you described, was one of oversupply, and we can see the outcome? I just want to understand how you achieved that.

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Jonathan Gray, Inghams Group Limited – CEO of New Zealand [25]

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Yes. Paul, thanks for the question. You’ll appreciate, I won’t get drawn on specific customers and conversations, but suffice to say, we have a range — we have some pass-through arrangements in place, and we have customers that we are in — we’re constantly in having constructive discussions with. An important note, as I mentioned in the previous answer, is in addition to some pricing movements across channel, we also delivered mix improvements. Thanks.

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Paul Buys, Crédit Suisse AG, Research Division – Head of Research and Director [26]

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Okay. And then maybe just a comment on the industry landscape there post, I guess, corporate action changes a while ago now. The view was, I guess, a more rational environment, obviously, IBDV didn’t necessarily help. But just keen to understand how you’re seeing the lay of the land from a competitive rationality perspective now?

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Jonathan Gray, Inghams Group Limited – CEO of New Zealand [27]

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Yes. Yes. We talked through on the strategy day and previous commentary around evidence of a more rational market in New Zealand. It’s fair to say over the 12 months — last 12 months, we’ve seen evidence of supply being more closely aligned to demand, which is encouraging. And then the recent market rebalancing, which is attributed to the IBDV issue as well, which we understand and that rebalancing is continuing to take effect. But we’ve seen clear evidence of supply being more closely aligned to demand through the last year. Thanks.

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Paul Buys, Crédit Suisse AG, Research Division – Head of Research and Director [28]

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And then just sticking with the topic of IBDV. Jim, I think you called out some volume gains related to that from an Aussie perspective as some of those exports were closed. Just keen to get an idea, I guess, of the quantum of positive impact there. And I mean, do you think you hold on to those now as kind of a permanent share gain? Or do they revert as and when markets reopen?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [29]

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Yes. Again, we’re not sure when the markets are going to reopen. But we are advantaged in that we, of course, compete both in Australia and New Zealand. So the downside of the IBDV did impact, as Jonathan mentioned, our New Zealand business relative to kind of a short-term oversupply. But we were able to pick up some volume on this end. But at the end of the day, it’s not really all that material. But hopefully, like any volume that we grab hold of, we will do whatever we can to hold on to it, where it makes sense to do so.

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Paul Buys, Crédit Suisse AG, Research Division – Head of Research and Director [30]

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Got it. And just my final one, kind of similar to one before in terms of the FP issues and how that flows through. Just wanted to kind of understand the mechanics as we go into second half ’20 now. So it sounds like your FP issues are largely resolved and that run rate is on track. Just wanted to clarify, I think last time around you called out that an offsetting — in the fourth quarter last year an offsetting factor was sort of reduced [staff] in the sense of executive payments. So just want to get kind of clarity as we go into second half now, the FP run rate gives you kind of a favorable comp in terms of PCP, but we’re going to see an offset from a resume — resumption of staff payments, is that right?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [31]

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Can you restate the last part of your question? Sorry, I didn’t quite get it.

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Paul Buys, Crédit Suisse AG, Research Division – Head of Research and Director [32]

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I guess, I’m just looking for the mix of headwinds and tailwinds now into second half ’20. So the — and as you start to cycle second half ’19. So FP looks like you’re cycling a positive one because you’ve now resolved those issues. But as I understand it, part of what you got last year was lower executive payments. So I’m just clarifying that I assume those come back on.

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [33]

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Yes. So as we stated, we are seeing momentum and we’re remaining very comfortable with what we anticipated would happened on half to half. And so that momentum continues and — from the first half into the second half. The only somewhat, I think, potential headwind, and it’s really too early to call, is consumer behavior relative to the impact that bushfires and a lot of other things have had. Because typically, when you have a situation like that, it can throw the demand/supply a little out of balance. But the good thing is consumption of poultry continues to increase, and we continue to supply it. So yes, those are the major ones.

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Operator [34]

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Next telephone question comes from Mr. Phil Kimber from Evans & Partners.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division – Executive Director of Consumer [35]

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I just wanted to circle back, if I could, on Craig’s earlier question on price in Australia. Just because if I look at the CPI data for poultry, and I know it’s not perfect, but the last — the September quarter and the December quarter up sort of 3% to 4%, but it looks like you guys haven’t got a lot of price in the half. Is that because you took your price earlier and it just took time to flow through to retail? Or is there something else that I should be aware of?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [36]

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Yes. I mean, we’re — I’ll turn it over to Gary here in a second. But one of the things that I didn’t say earlier to add to what I said is that we’re constantly in conversations with a number — I mean, all of our customers. And with some of those, as we’ve mentioned many times, we do have mechanisms for price pass-throughs. If — as grain escalates, for instance, if we are able to pass that through, you will see that as it escalates. And grain now is pretty much flat and has been for some time. Gary, do you have anything to add to that?

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Gary Mallett, Inghams Group Limited – CFO [37]

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So we have said it’s flat. But remember, it is a total and it is a mix. And we have had a far bigger improvement in our core poultry volumes — the total poultry volumes, which gives you a clue to mix. So we have been upgrading some of our former products that weren’t sold for human consumption, they aren’t necessarily at the same price as some of the core products as well. So there’s a mix impact as well in the pricing, but largely, it’s been flat.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division – Executive Director of Consumer [38]

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Okay. And can I ask, I know you won’t speak about specific contracts, but your biggest one, I think, comes up at some point in Australia. So I was just wondering, I would have sort of talked to win — over the next 12 months, what are some of the big contracts coming up? And how does it work in terms of you trying to manage your business for some of these big contracts? Because you called out lower bird weights, which I assume is because you had to sort of sell birds early to meet demand because of some processing issues that are well known. If you were to either win significantly more volume or lose volume from a tender, how do you set yourself up, knowing that it takes time to obviously grow the birds? So I mean, I’m really talking about the Woolworths contract here. So I don’t know if you can provide any color on that?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [39]

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No, I’d be happy to. And you are absolutely correct. We don’t speak specifically about any of our customers and nor will we. But I will say that with those customers in which we do have contracts, we are always in conversation with them about those. And to answer your question relative to if we gain volume or lose volume. Those decisions will be made and determined well in advance of any contract expiring. So we’re already — I mean, we’re always in conversations with them because it makes sense for them to make sure they have secure supply, and it makes sense for us to make sure that we can supply that demand. Does that help you?

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division – Executive Director of Consumer [40]

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Yes. Yes. And then — but you can’t — I mean, are there any big contracts of size that are coming up in the next 12 months?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [41]

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Yes. So we don’t have anything significant coming up in the near term, no.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division – Executive Director of Consumer [42]

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Okay. And one last one, if I can, just on the cash flow. I mean, you talked about an extra $44 million just 2 days after you closed the period off. I mean, if we looked at, say, the end of January to try and clear through the seasonality and some of the timing of date ends, would it be a cash cow conversion comeback to be more in line with circa 100%, which is where it should be?

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Gary Mallett, Inghams Group Limited – CFO [43]

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Of course, over time, it will be 100%. So January, we don’t report on January. But we are still in the higher seasonal sales through that Christmas period and through the January period is historically seasonally high period of time. So I’m not going to comment on January, but yes, we do expect to see that coming back through the next 6 months for June.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division – Executive Director of Consumer [44]

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Okay. So we’ll see a reversal effectively in the second half on the conversion percentage or certainly an improvement?

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Gary Mallett, Inghams Group Limited – CFO [45]

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We’ll expect to see an improvement on our working capital, yes.

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Operator [46]

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Our next question is from Aryan Norozi from UBS.

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Aryan Norozi, UBS Investment Bank, Research Division – Associate Analyst [47]

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First one for me. I think last result, you made 2 comments regarding the outlook. Firstly, you said guidance for FY ’20 to be less than ’19 and a return to growth in ’21 and also the first half earnings will be lower than the second half. Can you please clarify if that still stands?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [48]

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Yes. We’re — again, we remain very comfortable with what we said at full year, absolutely.

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Aryan Norozi, UBS Investment Bank, Research Division – Associate Analyst [49]

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Cool. And second one, can you please confirm if you expect cash conversion to move to that 90% to 100% for fiscal ’20?

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Gary Mallett, Inghams Group Limited – CFO [50]

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So I think, over time, we’ll be in that sort of 80% to 120% range. So yes, expect it to come back a lot closer by June.

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Aryan Norozi, UBS Investment Bank, Research Division – Associate Analyst [51]

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Over time as in over the next few years or over time as in next, like — for this fiscal year? So is that a medium-term target or…?

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Gary Mallett, Inghams Group Limited – CFO [52]

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So over time, we’ll be in that 80% to 120% range, it will depend on movements. By June ’20, I would expect it will be coming back closer to that 100%, yes.

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Aryan Norozi, UBS Investment Bank, Research Division – Associate Analyst [53]

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Cool. And can you just talk about the competitive backdrop, just — is the market rational between you and your major competitor? And have you seen any pricing pressure and maybe why the poultry was flat in terms of competitive pressure, please?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [54]

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No. I mean, it seems to be very rational and unless there is a consumer issue, which we do not see anything in our future or that’s on our radar. Yes, it’s business as usual, if you will.

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Operator [55]

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Our next question comes from Rod Sleath from Rimor Equity Research.

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Rod Sleath, Rimor Equity Research Pty Ltd – Equity Analyst [56]

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Just a few — I apologize, I will be going back over some stuff you’ve already spoken a little about. The first one is just a clarification. On Page 18, you show weak pricing. You describe it as, as observed by Inghams. I just wanted to clarify, is that what you observed effectively as spot or is that effectively the rate that you have purchased at? The difference being, is there a lead time before you get to those prices in your feed cost?

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Gary Mallett, Inghams Group Limited – CFO [57]

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Yes. So that’s what you see in the market.

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Rod Sleath, Rimor Equity Research Pty Ltd – Equity Analyst [58]

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Okay. So following on from that, I can clearly see that, that’s been relatively flat for some time. But if you still had PCP, prior calendar year period, this period, have you still had a reasonable increase in feed costs to take place this half just gone?

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Gary Mallett, Inghams Group Limited – CFO [59]

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So we don’t really comment exactly on our feed prices. So the best guide that we can give you is the market, but I do note your point that, yes, we do have timings around that, and we do have forward cover. But we don’t comment specifically on feed.

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [60]

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Yes. The other comment I would make, which is one of the reasons we put that map in the deck is, it’s fairly complex relative to where we source it at what price and how we transfer it within a state and across state lines. But Gary is correct. It’s — the best way to look at this is really what the spot market is. And then, as I stated earlier, we typically go out somewhere between 3 and 9 months on our coverage from a risk management perspective.

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Rod Sleath, Rimor Equity Research Pty Ltd – Equity Analyst [61]

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Okay. All right. And again, coming back to the lack of price increase, that is suggesting that you effectively have not had certainly large increases in feed costs come through in this period.

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [62]

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Yes, it’s pretty flat.

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Rod Sleath, Rimor Equity Research Pty Ltd – Equity Analyst [63]

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Otherwise it would be reflected. Okay.

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [64]

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That’s correct.

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Rod Sleath, Rimor Equity Research Pty Ltd – Equity Analyst [65]

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And could I also — sorry, I know you did touch on it, but I’m not quite sure I understood the answer. Could you just explain to me what the negative mix effect is that you’ve seen over the last half. I mean, I guess, I’m just looking at strong volume growth, strong market growth. So with limited supply, I would have thought your mix should have been — if rational, should have been stronger.

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Gary Mallett, Inghams Group Limited – CFO [66]

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Yes. So to be clear, what I’ve talked about on the mix, was we were upgrading some products that come from the birds that we didn’t necessarily sell into human consumption, e.g., paws, so when you then sell paws into your core poultries option, you would probably expect that, that price of paws will be at a lower level. So that’s what I meant by — [made comment saying it’s] negative is actually a positive thing for the business. We’re realizing more for that part of the bird.

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [67]

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In addition to that, what we said at the full year is the impact of the issue that we had in our further processing did affect our mix, and it affected us adversely relative to one specific channel. So now that we’re back in balance, that issue is behind us.

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Rod Sleath, Rimor Equity Research Pty Ltd – Equity Analyst [68]

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Okay. All right. And just on the paws, that should be actually positive for margin on its own, all else remaining equal, shouldn’t it?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [69]

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Yes. Any time we upgrade a byproduct, which is critical to this business, it’s always going to be a benefit.

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Gary Mallett, Inghams Group Limited – CFO [70]

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Absolutely. It’s positive. But remember, it’s a pretty small component of the business.

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [71]

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Yes, it’s very small.

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Rod Sleath, Rimor Equity Research Pty Ltd – Equity Analyst [72]

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Okay. You also mentioned the improvement in food nutrition moving to best practice. Are you able to give me any idea of what sort of improvements that potentially can lead to?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [73]

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Yes, we don’t share publicly what our feed conversion rates are for a variety of reasons. But I will tell you that as we stated at the Investor Day and at the full year, we are just in the throes of opening our research farm of which I toured that farm about 3 weeks ago, and it is extremely impressive what we’re — what we’ve built and, number two, what we’re going to get out of that. So we’ve only had about 2 or 3 flocks run through that so far. So it’s kind of TBD, but the real benefit in that is to being able to test different breeds, different feeds, different nutritional programs in the test farm by not impacting the market. So we don’t have to go out in the market and test it. And if you get it wrong, that stays with you for a very long time. So upside or downside, we want to do it in a very controlled situation.

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Rod Sleath, Rimor Equity Research Pty Ltd – Equity Analyst [74]

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Sure. And once you have found a combination that works really well. How quickly can those innovations be rolled out to your growers?

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [75]

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I mean, we’re looking probably a quarter or so, I mean, 3 months.

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Operator [76]

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And our next telephone question is from Craig Woolford from Citigroup.

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Craig John Woolford, Citigroup Inc, Research Division – MD, Director of Research for Australia & New Zealand and Lead Australian Consumer Sector Analyst [77]

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Maybe a question for Gary. I just want to follow-up on this CapEx issue. So CapEx will be higher in the second half. So how much higher? And where do you see CapEx versus depreciation over the next 2 years or so?

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Gary Mallett, Inghams Group Limited – CFO [78]

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Sorry, your question is for this year or into the future?

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Craig John Woolford, Citigroup Inc, Research Division – MD, Director of Research for Australia & New Zealand and Lead Australian Consumer Sector Analyst [79]

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Well, I mean, both because I want to — there are a couple of programs that have specifically called out things like hatcheries, et cetera, but how much does that full CapEx fall away in FY ’21?

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Gary Mallett, Inghams Group Limited – CFO [80]

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Yes. Okay. So we talk about the hatcheries, we have in the slide when they’re due to finish. So we’ve got Victorian hatchery second half FY ’21, Western Australia hatchery first half FY ’22. We’ll see a large — a substantial uplift in that CapEx in the next 6 months compared to the $16 million that we spent in the first half. And that will then continue through for another year or so through to those timings that I mentioned. So that’s the hatchery. So you will see a fair heavy spend of that through this next half and then into the next year as well.

The other projects I mentioned were the chillers in both WA, so we put one in Victoria, chiller into our turkey business as well and also an [expanse] and they will be done in the half, and then the expansion into New Zealand that I talked about, about the FP line, moving to fully cooked line, that will occur over the next 6 months and then also into the following year as well. So I think it’s the way to think about it, Jim mentioned that the depreciation equaling CapEx was a longer-term aspiration of where we’re heading. So we’re working our way through our strategy, and we’ll be having — we’ll be running higher CapEx levels than that in the next few years. That help?

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Craig John Woolford, Citigroup Inc, Research Division – MD, Director of Research for Australia & New Zealand and Lead Australian Consumer Sector Analyst [81]

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Yes. No, that makes sense. And maybe one, if I can sneak in. The volume — the mix effects that you’ve talked about around some of the upgrading of product but also the further processing disruption. What would volume have been if not for the further processing disruptions in the half — or volume growth, sorry?

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Gary Mallett, Inghams Group Limited – CFO [82]

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Yes, I don’t have that available at the moment. So we’ll have to get back to you on that one, Craig. So just on the CapEx, so I did mention earlier when I was answering your question around leverage. So we’re shooting through that we do have that higher CapEx, but as other people have also been talking to, we’re speaking around returning to working capital. So I see leverage is not moving that much come June. And going forward, I think we can go up to about 2x.

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Operator [83]

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There’s no more further questions at this time. I’d like to hand the call back to speakers for any closing remarks. Please continue.

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James B. Leighton, Inghams Group Limited – MD, CEO & Director [84]

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Thank you, operator, and thank you all for your interest in Inghams. It’s been a very busy and productive first half, and we’re looking forward to speaking with all of you in the coming days. So thank you.

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Operator [85]

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Ladies and gentlemen, that does conclude the call for today. Thank you all for participating. You may all disconnect. Good-bye.

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