Huon Aquaculture Group Limited Annual Report 2017 | Chairman's Message and MD's Review | Managing Director's Review

MANAGING DIRECTOR’S REVIEW


Photo of Peter Bender
Peter Bender
Managing Director and Chief Executive Officer



Huon Aquaculture’s third year as a listed company has undoubtedly been our most successful on record. Focussing on strong fish growth and delivering on strategic objectives has generated a significant turnaround in performance from the previous year.


With the implementation of our three year Controlled Growth Strategy (CGS) behind us, we are now focused on delivering the efficiency benefits that will come from integrating the latest technology and innovation throughout the business whilst at the same time supporting our capacity to grow production over the next 5 years, particularly in our offshore locations.

Our experience of a severe weather event through the summer of 2015-16, confirmed that the Company’s push into offshore farming in Storm Bay was and continues to be the right strategy to mitigate risk from climate change and severe weather events. This experience also underpinned our resolve to protect waterways, like Macquarie Harbour, that are under increasing stress through inadequate regulatory oversight and control. This has meant moving from engaging proactively with government to present our concerns, to one of direct action through the courts. This was never our preferred approach but the sustainability of our industry is vital not only to our business and the jobs it supports but to Tasmania’s reputation as leading the way in promoting environmentally sustainable growth.

Performance Overview

While sales volumes declined and overall revenue increased modestly in FY2017, profitability increased strongly due to; continuous improvement in farming and feeding strategies, better feed performance combined with ideal growing conditions during a mild winter and a cooler than average summer, and continued strength in the domestic salmon price. Reduced production tonnages, when compared to last year, reflect the decision in 2015 to bring forward the harvest of the 2014 Year Class due to the impending El Niño. As a result we started the 2017 financial year with much lower biomass levels than would normally be the case.

Operating EBITDA of $62.8 million was derived from annual sales revenue of $259.5 million. This compares with $26.4 million operating EBITDA from $233.7 million annual sales revenue in the previous corresponding period (pcp). The statutory profit (NPAT) of $42.2 million represents a significant turnaround from the previous year’s reported NPAT of $3.4 million.

The uplift in profit together with close management of working capital resulted in operating cash flow of $54.0 million. This figure was also influenced by the decision to hold back a payment of $17.6 million for feed quality issues supplied by Ridley AgriProducts, a matter which subsequently led to Huon pursuing a claim for damages. This was settled in the week prior to 30 June 2017 with payment made in July 2017.

Feed performance in a range of environmental conditions coupled with good fish husbandry is the foundation of successful and profitable production. This is evidenced in part by the dramatic improvement in fish growth once our fish were put on improved fish feed diets with the average fish harvest weight increasing 21% to 4.84kg in the 6 months to 31 December 2016 compared with 3.99kg in the prior six month period.

Whilst we measure performance using operating EBITDA, the Fair Value and Adjustment of Biological Assets can have a significant impact on the statutory results.

This adjustment in FY2017 was a $19.2 million increase in the Fair Value Adjustment of Huon’s Biological Assets reflecting the increased biomass levels from the recovery in fish weight and improved pricing conditions. The higher market value was due to the price increases and the improved sales channel mix, resulting in an increased average sale price.


Channel mix

Balancing Huon’s channel mix has been a strategic objective for the business for some time. The wholesale and export markets have been the primary channels through which the majority of our production has always been sold. However, a key development during the year was the execution of new sales agreements resulting in 22% of revenue being generated in the retail channel. This delivers a better balance to Huon’s sales channel mix and also provides a level of certainty in planning future production.

Overall net debt decreased from $62.1 million in FY2016 to $43.0 million. While this includes the $17.6 million payment withheld from Ridley which has subsequently been repaid (net of a $4.5 million settlement), gearing adjusted to include this repayment remains conservative at 21%.

Huon continued to bear the increased costs from the impact of El Niño and feed quality issues on its 2015 Year Class fish through the first half of FY2017. While this impacted the average cost of production per HOG kg for the year (+7.2%), the strong performance of the 2016 Year Class in the second half has driven a reduction in the cost of production (-12.3% on pcp) which is expected to continue in FY2018, underwritten by the productivity benefits from the Controlled Growth Strategy.

Operating Overview

The three key drivers underlying Huon’s performance during the year were:

  • better than average growth in fish weight due to a combination of ideal growing conditions and the improved fish feed diets,
  • better balance of our channel mix by selling a greater proportion of production to retail, and
  • the continued strength in the international and domestic salmon price.

There is no question, in our view, that Huon was in a better position to capitalize on each of these factors as a result of the commitment made in previous years to invest heavily in upgrading every stage of the production process.

Sales volumes fell 10% as the tonnage of whole fish sold declined from the record harvest of 20,463 kg in FY2016 to 18,448 kg. While we had planned for and flagged that production levels in FY2017 would be affected by the accelerated harvest, overall biomass growth was better than expected. A warm winter and cool start to summer supported ideal growing conditions during the first half which continued right through to the end of summer. The success of the Fortress Pens in reducing stocking densities and wildlife interactions at all sites, has given the fish a better environment in which to grow. More significantly the introduction of improved fish feed diets has delivered a rapid recovery in fish weight resulting in a strong improvement in performance between the first and second halves, as stated earlier. Over FY2017 the average fish harvest weight increased by 16% to 4.64kg compared with the second half of FY2016 (3.99kg) when fish were under the greatest stress.

Creating a more balanced and sustainable channel mix in which the retail market is a key contributor to long term, stable returns has been one of Huon’s strategic priorities. In August 2016 Huon signed a three-year agreement with a major food manufacturer for the supply of chilled packaged seafood. It increased the Company’s market share of the growing chilled packaged fresh salmon category in retail stores across Australia. This is a category that is currently trading well below its potential in the Australian market when compared with penetration internationally.

This represented a significant milestone in Huon’s execution of one of its three strategic business objectives: to grow the market through increased consumption, better channel mix and the enhancement of our sales and brand. Around 23% of production volume is now being sold through the retail channel, compared to an average of 10-12% in prior years.

International Salmon Prices
Picture of Salmon

International salmon prices rose strongly in the first half of FY2017 from the low experienced in November 2015. Severe outbreaks of sea lice in Norway and Scotland, as well as a deadly algae bloom that hit Chile in early 2016, meant supplies of global farmed salmon fell almost 9% from the previous year, the first decline in six years and the steepest fall in a quarter of a century. Over the year to June 2017 international salmon prices, while volatile, have traded at elevated levels and despite an expected increased global supply it is anticipated to fall below meeting demand. Prices in the domestic market are expected to continue to trade at similar levels to those experienced in the past year.

With production tonnages down on FY2016 and 23% being allocated to the supply of new retail contracts, Huon effectively exited the export market in FY2017. However we expect to increase our export activity over the next two years as we consolidate some new and longer term relationships in the Asian market. At the same time we remain focused on supplying the rising domestic demand for salmon across both the retail and wholesale market.

FY17 FY16 FY15
Lost Time Injury Frequency Rate (LTIFR)
Number of injuries per 1 million hours worked
3 7 27
Average Lost Time Rate (ALTR)
Hours lost per employee
12 16 19
Incident Rate (IR)
Number of Lost Time Injuries per 100 employees
0.6 1.3 5.2

People and Safety

Huon’s “Safety First” ethos has resulted in continued improvement in its Loss Time Injury Frequency Rate (LTIFR) in FY2017, from 7 in the previous corresponding period to 3.

Building our people’s capability through workforce planning and targeted development is playing a critical role in Huon delivering its business strategy. Recruiting and retaining high calibre employees is a core people strategy and succession planning is also a high priority.

Huon has a strong commitment to building the skills, knowledge and capabilities of its people to ensure the business reaches its full potential. This commitment is not only building the capability of the current workforce but preparing the business for future opportunities. It is recognised within Huon that having a strong leadership capacity and a well-trained work force underpins a business that is productive, profitable, sustainable, and allows us to embrace emerging technological advances.

Managing Risk

Key risk areas: FY2017 measures:
Agricultural risk
(disease, algae)
  • Continuous improvement in farming and feeding strategies, transfer of fish onto improved feed diets, resulting in rapid recovery in fish weight in the second half following feed performance issues and severe weather conditions. New feed supply contracts in place and ongoing feed diet trials. Participation in the industry-wide selective breeding program and support for the rapidly expanded research capability for vaccine development at the Aquatic Animal Health and Vaccine Centre of Excellence (AAHVCE) in Launceston.
Environmental risk
(weather, wildlife)
  • Decreased stocking densities and installation of oxygenation system in Macquarie Harbour, legal action against the Tasmanian Government and the EPA through the Federal and the Tasmanian Supreme Court in relation to mismanagement of Macquarie Harbour. Increased utilisation of offshore sites to mitigate impact of severe weather events.
Social and Market risk (reputation, competition, consumer preferences)
  • Significantly increased penetration of the retail channel providing better balance to sales portfolio. Increased market share of the growing chilled packaged salmon category supported by use of well-known brands such as John West. Continuing to research innovative product extensions.
  • Deep understanding of broad social and local community expectations of Huon’s operations are reflected in decision making across the business, including the CGS. Effective engagement with a wide range of stakeholders regarding the social and environmental benefits of Huon’s CGS occurred and is ongoing during a period of increasing concern over industry practices.
Safety risk
  • Improvement in lost time injury frequency rate

Taking responsibility for the salmon industry’s management of environmental risk

Constantly monitoring and managing risk is core to the way Huon operates its business each and every day. Effective risk management is fundamental to the creation of sustainable long term revenues in aquaculture. For the most part, our activities go unnoticed to those outside the business however, in FY2017 that changed when we decided to take our concerns public regarding the specific risks Huon was facing as a result of the environmental threat to Macquarie Harbour.

Macquarie Harbour is particularly important as it provides a discrete biosecure region where the disease status is uniquely different to other growing areas in the state. For this reason, together with its natural beauty and World Heritage listing, protection of this waterway is of paramount importance not only to Huon and the salmon industry, but to all Tasmanians.

Since 2014 the Tasmanian government, as regulator of the Harbour, has set increasing biomass limits and applied other management controls that have led to, or caused, deteriorating environmental conditions. There was no change to this practice in 2016 when conditions in the Harbour deteriorated to levels that threatened its environmental values and yet the government lifted the biomass cap to an unprecedented level of 21,500 tonnes.

In July 2016, the Tasmanian Government handed control of Macquarie Harbour over to the independent Director of the Tasmanian Environmental Protection Authority (EPA) at which time a review of environmental conditions in the Harbour was undertaken. In February 2017, the EPA Director made a final biomass determination of 14,000 tonnes that, based on the available scientific evidence, set a limit that, in Huon’s view, was still well in excess of the level the waterway could support. It was at this point that Huon made the decision to commence legal proceedings in the Supreme Court and Federal Court challenging the EPA Director’s and Tasmanian Government’s management of Macquarie Harbour.

Undertaking legal proceedings was not our preferred approach and has only come after years of engaging directly with government and exhausting all other avenues at our disposal. In the end we felt it was the only way to draw attention to and hopefully remedy, an issue that has the potential to seriously damage the reputation of our industry and the long-term security of the waterway for salmonid farming. The first component of these actions will be heard in the Federal Court in November 2017.

A summary (Macquarie Harbour Timeline) of key regulatory, biomass, scientific findings and legal proceedings regarding Macquarie Harbour since the approval to expand salmon farming was granted in 2012 is available from the sustainability section of our website.

Huon believes that to maintain social acceptance both in local communities and the wider public, the Company must farm ethically and transparently. Huon achieves this by taking a long-term view and this is reflected in the Company’s planning and decision making, particularly as it relates to Macquarie Harbour. Broad social acceptance is needed to ensure the safe, sustainable growth of the Company over time.

While environmental risk is only one of Huon’s key areas of risk which are actively monitored and regularly assessed as part of our operational management strategy, it is one that has undoubtedly received a greater proportion of Huon’s attention during the past year.

Outlook

Demand for salmon from Australian consumers is expected to continue growing at around 10% per annum and the demand supply dynamics internationally are such that pricing is expected to remain above the long term average. Huon is well placed to take advantage of demand increases with lease space availability, particularly in offshore locations, allowing the Company to grow in-line with demand.

While Huon’s primary focus will continue to be growth of the wholesale business, our increased exposure to the retail market as a result of the new retail supply agreements entered into early in FY2017, provide a valuable diversification in Huon’s channel mix. We expect sales into this market to at least reflect the growth in demand, with a particular focus on the fresh component of the retail sector.

Particular opportunities in the export market remain of interest to us and we intend to take advantage of the strong demand for the Huon brand in Asia. Huon expects to increase sales penetration of the Japanese market and harness new opportunities that will assist Huon to further leverage its sales into a range of other key high-performing Asian markets.

Capital expenditure will increase to around $65 million from $35 million in FY2017.

With production levels likely to remain low in Macquarie Harbour, continued production expansion will occur at our Storm Bay offshore sites. Planning is also underway for our land based growout nursery, with construction expected to commence during FY2018, with first fish to sea expected in FY2019.

FY2018 has started well with favourable growing conditions and fish responding well to improved fish feed diets and the fortress pens. While we still have the higher risk growing cycle of summer ahead of us for FY2018, current estimates have our harvest volume around 24.5 thousand tonnes. While market pricing levels are expected to be similar to FY2017, we are forecasting higher export sales during FY2018, as a result of the significant increase in production tonnes. This is expected to result in overall lower average prices than in FY2017. The full impact of the CGS investment expected to be reflected in substantially improved operating efficiencies in FY2018. As a result we are confident that profitability will continue to grow over the coming years.

Peter Bender Signature
Peter Bender, Managing Director and Chief Executive Officer

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