Dunham Winoto - Pilgrim's Pride Corp. William W. Lovette - Pilgrim's Pride Corp. Fabio Sandri - Pilgrim's Pride Corp..

Heather Jones - The Vertical Trading Group LLC Ken Zaslow - BMO Capital Markets (United States) Jeremy Scott - Mizuho Securities USA LLC Adam Samuelson - Goldman Sachs & Co. LLC Lubi Kutua - Jefferies LLC.

Good morning, and welcome to the Third Quarter 2018 Pilgrim's Pride Earnings Conference Call and Webcast. All participants will be in listen-only mode. At the company's request, this call is being recorded.

Please note that the slides referenced during today's call are available for download from the Investor Relations section of the company's website at www.pilgrims.com. After today's presentation, there will be an opportunity to ask questions.

I would now like to turn the conference over to Dunham Winoto, Director of Investor Relations for Pilgrim's Pride. Please go ahead..

Good morning, and thank you for joining us today, as we review our operating and financial results for the third quarter ended September 30, 2018. 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 we may discuss.

A copy of the release is available in the Investor Relations section of our website, along with the slides we will reference during this call. These items have also been filed as 8-Ks and are available online at www.sec.gov. Presenting to you today are Bill Lovette, President and Chief Executive Officer; and Fabio Sandri, Chief Financial Officer.

Before we begin our prepared remarks, I'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 day of this release.

Other additional factors not anticipated by management may cause actual results to differ materially from those projected in these forward-looking statements. Further information concerning those factors has been provided in today's press release, our 10-K and on our regular filings with the SEC. I'd now like to turn the call over to Bill Lovette..

Thank you, Dunham, and good morning, everyone. Thank you all for joining us today. For the third quarter of 2018, consolidated net revenues were $2.7 billion versus $2.79 billion from a year ago, resulting in an EBITDA of $156 million or 5.8% margin versus $464 million a year ago or 16.6% margin.

Our net income was $29 million compared to $333 million in the same period in 2017, while adjusted earnings were $0.21 per share compared to $0.98 per share in the year before.

Our performance during Q3 is a testament to the breadth and diversity of our portfolio, which is structured to be more resilient compared to our peers by having a much more balanced performance across all market conditions while still giving us the opportunity to capture any upside, despite a very challenging pricing environment in the U.S.

commodity chicken, a slowdown in Mexico and fee cost pressures in Europe. Our team members have once again focused on our strategy and we're proud of their contribution.

We're also continuing to leverage our key customer approach to drive further growth beyond just the underlying market conditions and though we're proud of the progress we've made in terms of our relative performance over the last few quarters and years to the competition, we're not satisfied and are continually refining our portfolio strategy.

We remain diligent and looking for growth opportunities and product differentiation both organically as well as through acquisitions to generate greater value while contributing to the evolution of our portfolio and supporting our vision to become the best and most respected company in our industry.

During Q3 we continued to experience challenging counter-seasonal market conditions in the U.S. large bird deboning segment, while demand was much more in line with normal seasonality in the less commoditized segments. The sources of negative impacts to our U.S.

business were large bird cut-out, live production and breeder costs, investments in brand and growth in prepared-foods, as well as salary and wage increases given to our team members. These impacts to profitability were partially offset by improvement in portfolio mix, fee conversion rate, plant costs and yields.

Customer demands and margins within our small bird and case-ready operations have continued to perform better than commodity and served as an offset, and our leading share in these markets and differentiated product offerings have continued to give us a competitive advantage relative to our peers on a more narrow market approach.

While our overall chicken supply in 2018 has been growing at a similar pace year-to-date versus last year, a combination of less featuring by both retailers and foodservice operators as well as higher availability of other proteins due to a decline in exports have pressured growth in chicken demand, especially in the commodity segment.

We believe retailers are going to revert back to spending more of their promotional dollars back into chicken based on past trends and the shift could begin as soon as after the New Year as chicken demand usually improves post the New Year year-end holidays and chicken has remained a strong traffic generator for many retailers.

In foodservice, we're already starting to see more chicken promotions after a large number of beef features earlier in the year as operators have already began to recognize the attractive value proposition in chicken which could signal the beginning of a shift in focus.

While the market for commodity chicken remains challenged, our team continues to search for innovative ways to differentiate our portfolio and reduce the proportion of commodity to further insulate our margins from market fluctuation and improve our relative performance to our competitors.

For example, even with the main bird size categories, we have multiple strategies to improve our product diversity and market exposure.

Last year, we converted Sanford, North Carolina from a big bird commodity plant to specialty organic case-ready plant and it's continued to exceed our expectations and profitability target with a very stable performance.

Earlier this year, we also moved one of our big bird deboning plants to full No-Antibiotics-Ever and veg-fed again to reduce the impact from pure commodity, working with key customers to support their growth expectations, improve our margin profile, and provide a more consistent performance.

Most recently, we've made the decision to convert another one of our commodity big bird deboning facilities to a small bird deboning plant working again with a key customer to fulfill their expansion plans as demand has continued to outstrip our capacity to supply that growth.

Amidst continued uncertainties regarding the direction of the international trade, the U.S. export demand has been solid which we view as a positive, considering the impact of a stronger U.S. dollar. U.S.

chicken has remained attractive relative to other global exports and we have a very good access to grain, a leadership position in technology, and very competitive costs. Our Prepared Foods businesses is continuing to improve and growing at a solid pace of 10% revenue and 13% in volume year-over-year.

During the last few years, we've been investing in our Prepared Foods plants, our operations and our people to expand our capacities and capabilities and investments are starting to generate very solid results. We're continuing to build out for innovation and marketing to drive strong growth for the future.

The investments and focus have yielded the increase in performance and the potential further growth remains available. Our commitment to growth in Prepared Foods gives us an improved margin profile by reducing earnings volatility within our entire portfolio.

We continue to support the investments and future expansion of our well-regarded Just BARE chicken brand and it has steadily exceeded expectations with key customer segments.

Just BARE remains the top choice of consumers in online sales and, in quarter three, we continued to see increased marketing support for the brand via strategic partnerships that allow us to grow efforts in supply chain improvements, future innovation and increased opportunity for national growth.

Just BARE has recently expanded our rotisserie distribution into the Northeast and Midwest markets, increasing our brand awareness and distribution growth, and we continue to see significant market opportunities and we've made considerable progress toward our goal of national distribution.

Our results and market prices in Mexico during Q3 were below expectations, and while Q3 is seasonally the weakest quarter of the year, industry supply and demand dynamics were even weaker than usual which weighed on pricing.

Supply grew more than expected as a reaction to strong prices in the first half of the year and also as a result of very good weather and outstanding growing conditions.

While Mexico can be quite volatile quarter-to-quarter, historically, our operation has produced very good margin performance on a full year basis and we expect this trend to continue in the future.

Year-to-date, Mexico is delivering 12% EBITDA margins and we expect an improvement in Q4 and believe our performance for all of 2019 in Mexico will follow a summer seasonal patterns relative to our past performance in past years.

Our team's focused on operational excellence and offering a differentiated product portfolio continues as a part of our strategy to continue our competitive positioning. We are maintaining the pace of new innovative product introductions.

Our Prepared Foods are growing at double-digit rates and are generating excellent results under both the premium Pilgrim's and Del Dia brands. And those brands have continued to receive very favorable acceptance by our consumers in Mexico.

Our European operations have continued to produce an improved performance compared to last year, with 3% growth in revenue and 130 basis points rise in EBIT margins versus last year despite an increase in feed cost due to weather events in Europe.

Our results are a proof of our more stable business model, while our team members also improved the operations and contributed to the strong performance by continuing to focus on cost optimization, cost control, excellent customer relationships, synergy capture and a culture of constant innovation, while still maintaining a consistent margin performance.

As the cost of ingredients, in particular wheat, rises given weather impact across the summer in Europe, we work within our supply agreements with key customers to reflect and recover or mitigate these costs in subsequent quarters. Where we have no formal supply agreements, we're engaging immediately to recover the higher input costs.

The integration process is going well and we're above our run rate in capturing $50 million in expected synergy targets over the next two years.

Our team has continued benchmarking operational efficiency and productivity and have found additional opportunities to create value through feed formulation changes, yield management and labor efficiency at our European operations.

We're applying our methodologies in Europe to generate operational improvements and focus on closing the gaps to the legacy operations. Our emphasis in applying our key customer strategy is proceeding well and will give us a much more resilient margin structure.

We're also looking for additional value creation potential in Europe as we have in the U.S. and Mexico to drive even greater earnings performance.

As a part of the integration activities, our team is driving for an increased focus on utilization of the whole bird by opening up more opportunities and diversifying into new markets for dark meat, offal and other products. We will continue to invest and optimize our production facilities across Europe to make them more efficient and competitive.

And although early, the increase in operational focus is already starting to pay off as our European operations have improved their relative performance over the competition there. Beyond that, we are looking to deploy capital in opportunities across Europe to drive future growth both organic and inorganic and further improve diversification.

We're supporting further innovation in our value-added operations with significant investment to expand our gluten-free capability to target a growing consumer trend for gluten-free products. The plant-based protein market is growing strongly in the UK as part of a wider Flexitarian Diet approach.

And we believe the innovation we're developing in Europe can be adapted to other markets we're in, giving us yet another way to tap into consumer desire for an alternative form of protein. Although still small, we expect the volume from this segment to grow strongly over the next few years driven by robust consumer demand.

We continue to support our consumer development and expect to see further growth this year, driven by interest in meat-free snacking. Looking at feed prices, USDA is projecting the second largest corn crop in history in a record 180.7 bushels per acre yield. Despite lower corn acres and demand for U.S.

corn exports, the corn carryout is projected to exceed 1.8 billion bushels. Corn acres in the U.S. next year will likely benefit from poor soybean economics, allowing U.S. supplies to increase further. A strong U.S. dollar will also continue to promote acreage expansion for grains globally. Soybean supply from the U.S.

will reach record high levels this crop cycle due to a combination of record yields and poor export demand. USDA has currently forecasted the U.S. carryout at 885 million bushels, a new record. Trade disruptions with China, the U.S.

largest export destination, are a major headwind to soybean prices, and we do not expect feed input prices to be a major headwind to margins in the near term or medium term. For 2019, USDA is expecting total U.S. chicken industry production to grow in a similar range to 2018.

And while there's been some marginal improvements in breeder egg production recently, we believe that reduction is structural and that the new generation of breeders will remain less productive than previous. Also, despite the announced new capacities, some of these are replacing existing Saturday schedules and the tight labor conditions in the U.S.

are likely to continue. As a result, we believe the pace of the industry capacity growth in the mid to near-term will remain similar to current levels.

In spite of more availability of other proteins and a challenging commodity chicken market, the outlook for chicken demand in less commoditized segments this year continues to be good overall and the supply-demand there remains relatively better balanced. With the U.S.

economy continuing to be strong, very low unemployment, together with higher disposable income, are driving households to consume more proteins throughout the day. This implementation of new trade agreements and trading partners should gradually reduce the amount of domestic protein availability and put less pressure on chicken and drive more demand.

Foodservice operators are all already starting to turn their focus more on chicken, and we can expect increased feature activity by retailers after the new year.

And while we are already well-balanced in terms of our bird size exposure, we'll continue to look for opportunities to incrementally shift our product mix and reduce the commodity portion of our portfolio by offering more differentiated products to our key customers while also optimizing our existing operations by pursuing our operational improvement targets.

We believe our key customer approach is strategic and creates the basics to further accelerate growth in important categories by providing more customized and innovative products to give us a clear competitive advantage. Given our experience with state-of-the-art deboning equipment in Europe and the U.S.

and our quest to continuously improve the work environment and safety of our team members, we've made steady advances in developing robotic solutions for our processing facilities. Our focus has been on addressing process steps where both ergonomics and employee fatigue due to repetitive motion are key concerns.

We're excited about the progress to-date, and we're in a position to test a proprietary commercial scale robotic technology in a labor-intensive process area where no automated solution exists today. Construction of the system is underway and we'll begin commercial scale testing at one of our facilities soon.

We believe our commitment to developing advanced automation technology will not only create a sustainable competitive advantage but also allow us to economically address the ongoing issue of labor availability in our industry. In September, Pilgrim's released our 2017 sustainability highlights report.

This report builds on a comprehensive 2016 sustainability report detailing the achievements of more than 54,000 team members and 5,200 family farm partners in 2017 and updating our progress toward reaching our 2020 sustainability targets.

Compared to 2016, Pilgrim's decreased severe incidents by 26% significantly outperforming our 15% year-over-year reduction target. We also decreased water and fueling use intensity by 1.3% and 2.7% respectively and decreased greenhouse gas emission intensity by an impressive 8.2%.

We have maintained our focus on animal welfare, passing all third party audits with scores ranging from 97% to 100%. In 2015, we set ambitious 2020 sustainability goals to ensure that we stay focused on continuous improvement. We remain focused on these goals outperforming our team member health and safety goal by 11% in 2017.

In addition, we're on track to beat our goals in supply chain responsibility, natural gas use intensity, electricity use intensity, greenhouse gas emissions intensity, and animal welfare. Water use has posed a challenge and we'll continue to heighten our focus to ensure that we make progress on our 2020 promise.

We continue to invest heavily in the future of our company, our team members and agriculture as a whole by listening to consumers advancing best practices and harnessing the latest trends to ensure Pilgrim's products remain environmentally responsible, socially sound and economically viable.

We believe we can play a leading role in feeding the world in a manner that aligns with the consumer values and results in healthy quality, high quality products that benefit families and our society and shared future.

We're confident in our focus on sustainability will continue to position Pilgrim's as the global industry leader in the production of high quality sustainable chicken products.

Before I turn the call over to Fabio, I want to recognize the great work of our team in executing our strategies which produces a clear long-term margin advantage versus our peers in this dynamic and cyclical industry. Our portfolio is specifically designed to minimize the impact from cyclicality of individual market segments.

The result is evident in all three geographic regions in which we operate and it magnifies our relentless pursuit of operational excellence and presence in diverse and differentiated business models, segments and channels. For the long term, we expect this competitive advantage to persist.

With that, I'd like to ask our CFO, Fabio Sandri to discuss our financial results..

Thank you, Bill, and good morning, everyone. We reported $2.7 billion in net revenue during the third quarter of 2018, resulting in an adjusted EBITDA of $156 million or 5.8% margin. That compares to $2.79 billion in net revenue in an adjusted EBITDA of $464 million or 16.6% margin the year before.

Net income was $29 million versus $233 million in the same quarter of 2017, resulting in adjusted earnings per share of $0.21 compared to $0.98 in the same quarter of last year. Our EBIT in U.S. was $74 million or a 4% margin for Q3.

Small bird and case-ready continue to be relatively better market for us as chicken has remained compelling to our customers, despite higher availability of other products. On the other hand, similar to Q2, the large bird deboning commodity was counter-seasonal and challenged during most of the quarter, although prices have stabilized recently.

As Bill mentioned, we believe the commodity segment was hurt by the increase in emphasis by the retailers and foodservice on non-chicken promotion. Our sales in the prepared segment continued to improve relative to last year with an increase of 13% in volume.

Despite the counter-seasonal trend of the commodity segment, we have the portfolio diversification to all bird sizes, including small bird and case-ready and also international operations, which is designed to mitigate the volatility of any given segment and protect the downside.

After a very strong first half market conditions in Mexico, favorable growing conditions and good weather drove industry supply to grow much faster than expected in a period of seasonality less demand, pressuring prices during the quarter. Our EBIT in Mexico was negative $12 million or a minus 4% margin.

While the market impacted our results during the quarter, we have a very strong team in Mexico who has been over-delivering performance for us in terms of relative performance to the major competition in the past few years due to their strong operational focus and excellent determination and we expect this trend to continue in the future.

We remain focused on supporting the long-term growth in Mexico. Investments in our production at the new Veracruz complex are tracking well and its performance is exceeding our expectations. And we expect to double the size of the operation including the expansions in the feed mill and hatchery by the beginning of the year.

We have been innovating in Prepared Foods including adding products using the premium Pilgrim's brand. Our investments have continued to produce very good results in Mexican Prepared Foods and the volumes are 29% higher than a year ago and our Pilgrim's and Del Dia brands capturing roughly 35% of the prepared foods market.

To maintain our growth and continue to innovate we launched fresh chicken under the premium Pilgrim's brand including No-Antibiotics-Ever, which have continued to see strong demand.

Our strategy is supportive of the goal to increase our higher margin differentiated products while having private coverage from entry level to premium, both in fresh and prepared in Mexico. The expansion in sales and margins at our European operations have continued. Our EBIT in UK and Europe was $24 million or a 5% margin.

The integration is going better than expectations and we are excited with the geographical diversification and growth potential for us while evolving our portfolio and creating a sustainable advantage through opportunities to capture the upside in the market, but protecting the downside.

We are ahead of our target of $50 million in synergies over the next two years including optimizing the product portfolio, operational synergies and implementing zero-based budgeting.

We've increased efficiency across the value chain by enhancing sourcing and production, improving life costs, yield improvements and the global management of feed sourcing. We will leverage our marketing and sales infrastructure to optimize SG&A costs.

We have a very good track record of successfully capturing synergies and delivering better operating results while improving the relative performance to the competition and the markets.

We are confident we have the methodology and the team in place to similarly continue to grow the profits at our peer operations and leverage our expertise and experience to improve the rest of our global operations.

As part of the integration activities, our team is driving for an increased focus on utilization of the whole bird to identify more opportunities and strengthen our cut-outs. We'll continue to build additional key customer relationships, identify value creation potential and support and improvement in the financial performance of the business.

As another example the value of the key customer partnerships, with cost of feed ingredients, particularly wheat, moving higher in Europe, we were able to better reflect the change on our prices through our long-term relationships with these customers.

During Q3, our SG&A reached 3.1% of sales, reflecting the inclusion of support for expanding the Just BARE brand nationally, the investments for our new Prepared Foods products both in U.S. and Mexico as well as the addition of the new European operations.

We expect to reach operational improvements and synergies this year in line with last year or around $150 million, reflecting the benefits of the acquisition and supporting the evolution of our mix and production capabilities and improving our ability to service key customers throughout the globe.

We'll continue to prioritize our capital spending plans this year to optimize our product mix that is aimed at improving our ability to supply innovative, less commoditized products and strengthening partnership with key customers. We expect to invest $325 million on CapEx to account for the inclusion of GNP and Europe within the budget.

We reiterate our commitment to invest on strong return over capital employed projects that will improve our operational efficiency and tailor customer needs to further solidify competitive advantage for Pilgrim's.

Our balance sheet continues to be strong, given our continued emphasis on cash flows from operation activities, focus on management of working capital, and disciplined investment in high-return projects.

During the quarter, our net debt reached $1.9 billion with the leverage of 2 times pro forma last 12 months EBITDA at the lower end of our optimal range of 2 to 3 times. Our leverage remains at a good level and expect to continue to generate strong cash flows, increasing our financial capability to pursue strategic actions.

We expect 2018 interest expense in the range of $120 million on a normalized basis. Our tax expense was impacted by $26 million during the quarter for the adjustments for the new Tax Act due to a final calculation on the liability of the undistributed earnings on the foreign income.

Adjusting for the impact and other changes, our EPS on the quarter will be $0.24 per share. Going forward, we expect our effective tax rate to be around 24%.

Yesterday, we also announced that our board has approved a new $200 million share repurchase program, which demonstrates our commitment to creating shareholder value, our financial discipline their confidence in the future. We have a strong balance sheet and a low leverage.

We remain focused on exercising great care in ensuring that we create shareholder value by optimizing our capital structure, while preserving the flexibility to pursue a growth strategy and we'll continue to consider and evaluate all relevant capital allocation strategies that will match the pursuit of our growth strategy and we continue to review each prospect accordingly to our value creating standards.

Operator, this concludes our prepared remarks. Please open the call for questions..

We will now begin the question-and-answer session. In the interest of allowing equal access, we'd request that you limit your questions to two then rejoin the queue for any follow-ups. Our first question comes from Heather Jones with The Vertical Group. Please go ahead..

Good morning. Thanks for taking the question. I want to ask some questions about the operations, but my first question is on the share repurchase. So, Fabio, if I remember correctly, in the past, you've expressed a hesitancy regarding the share repurchase just because of the relatively narrow flow of the shares.

So just wondering what brought about the change of mind?.

I think we're looking into every possibility of creating shareholder value, Heather. And at the current levels of the share, investing in business is a great investment..

And as a follow-up on that, am I understanding the press release correctly that you intend to repurchase $200 million within the next 12 months? And as a follow-on to that, will any of the shares be purchased from JBS or is the intention to repurchase from the $50-odd-million float?.

No, the intention is to buy from the market. JBS does not intend to sell its shares. And the program is open for 12 months and we have a limit of $200 million..

Heather, this is....

Okay. So you're not committing – okay, okay. Sorry go ahead..

This is Bill. Sorry to interrupt. It's just a reflection of our view of the future in this business how we constructed a long-term strategy, and then how our team is executing against that strategy.

I think it's just we have confidence that the current share value that it's a great opportunity to buy something of great value, which is what we do and our view of the future..

Okay..

On top of that, our leverage continued to be low and our commitment to pursue our growth strategy remains intact..

So it's your intention, assuming the shares – at these current levels, it would be your intention to do $200 million in the next 12 months?.

Yes, it is the program..

Okay. Then moving on to the operations.

Mexico, I know you mentioned that weather, et cetera, drove supply to be greater than expected, but how did demand shape up? Did demand come in lower than expected and also contributed to that imbalance or do you think it was solely related to supply?.

better weather and less disease pressure. Mexico is a market where from time to time we get quite a bit of pressure on livability and we had much less of that I think in part due to great growing conditions from the weather and it caused supply to outstrip what current demand is.

Q3, as a reminder, is typically the quarter with the least amount of demand and it was really no different than any typical Q3 in that respect. And it lasted a bit longer than we've seen in some years. But as normal, we do see a bounce back in demand in Q4. We, in fact, have begun to see that demand and we're profitable now in Mexico.

And we think Q4, and further into 2019, it's going to follow a normal seasonal pattern. And if you go back and look at the last few years of our financial performance in Mexico, it's been great on a relative basis and we don't expect that to change..

And in the long-term, Heather, just like Bill mentioned, Mexico is a growing economy. And as the population increases their disposable income, it leads to a significant growth in the protein consumption..

Thank you. Just real quick on the share repurchase, a details question.

When does your window open for that?.

It will be next Tuesday..

Next Tuesday. Okay, thank you..

Our next question comes from Ken Zaslow with Bank of Montreal. Please go ahead, Ken..

Hey, good morning, everyone..

Good morning, Ken..

Good morning, Ken..

So a couple of questions. One is when you think about the U.S.

margin opportunity or last year over at this point, how do you think the path or the milestones that we should think about that we might be able to see a return to more stable profitability, call it, in several years or how long do you think it will take it and what do you think are the key milestones for which we would see an improvement?.

Normally, Ken, we see an increase in demand after the first of the calendar year, which is fairly normal; and we don't have any reason to believe we will not see that pick up in 2018.

Additionally, we think the export environment will improve for not only chicken, but more importantly, in this particular case, pork and beef and less production or growth of both pork and beef next year versus last year. At least, that's our forecast. So that's what we believe at this point.

We think that 2019, as far as chicken demand, will follow the normal seasonal pattern. We do think relative to 2018 we'll get more feature activity with chicken. It seems that both foodservice operators and retailers decreased significantly their focus on chicken promotions in deference to beef and pork.

We think chicken frankly will get back to a more normal share of that feature activity..

Will that be enough to restore your margins to like 2016 levels or is that just, hey, where going to be less bad than right now?.

I think it will improve from where it is – where it's been recently. I don't know that I could compare it to 2016 or 2017 or any other year, but I do think that it can improve in 2019..

Just to complement, Ken, on foodservice, we're already seeing more promotions on chicken and the RPI which includes the foodservice expectations is still expanding. So we're seeing a pickup in the demand for chicken in the foodservice..

Okay. But just to be clear though, you don't expect any production cut and the thing that's going to get you to an improvement is just the increased demand. You don't see any other tension or pull or anything that would accelerate the opportunity? And then, I'll leave it there..

Yeah. We are not aware of any production cut and intentions and we do expect demand improve..

Other than the seasonally normal cuts for us, for the Q4..

Yeah. That's right..

All right. Thank you guys very much..

Our next question comes from Jeremy Scott with Mizuho. Please go ahead, Jeremy..

Just between freight, labor, grow or pay, I think you've had – you averaged a 3% gross margin headwind in 2018 thus far.

Can you talk about to what extent does that repeat in 2019 and what's your line of sight there? And I think maybe just a follow-up to that, you mentioned that the offsetting force to some of this capacity growth coming online over the next few years will be the loss of Saturday runs.

But just looking at the egg set data, it seems like we're getting that a bit right now and again seasonal cuts withstanding.

But to what extent is that a limiting factor over the next couple of years as the capacity comes on line?.

So, in terms of the transportation, we have P&Ls by plant and by products and dedicated fleets in some lines. So we identified a total annual impact of $29 million dollars. We are adapting our prices and our delivery options depending on the specific local conditions.

And we mentioned before in other quarters, we have two-thirds of the impact already mitigated or in the process of being mitigated. So, I think transportation is not going to be a huge headwind for us in the future..

And on the labor side, we continue to invest in automation technology. As we spoke, we've installed some automated deboning machines for the front half of white meat this past year. We will continue to invest in more facilities especially in the plants where we face the most pressure for labor supply.

And as I mentioned in the prepared remarks, we're working on a proprietary robotic system to replace some of the harder jobs that create the most turnover in our facilities as well.

So, it's really, regardless of market conditions, we're continuing to be focused on improving the labor performance, labor efficiency and therefore, reducing costs going forward..

Also in terms of headwinds, this quarter we have an impact of around $65 million in feed ingredients. And then with everything that Bill mentioned about the size of the crop for next years, we expect that to moderate..

Okay.

And then just maybe can you give a little insight on your organic pricing in this soft environment? To what extent is there elasticity on an organic or in elastic pricing on an organic side when you have a drop in underlying commodity prices?.

We've seen no impact to demand or pricing pressure in that organic segment. And as a matter of fact, we're bumping up against capacity. And so it's forcing us to look at the growth opportunities for certified organic production just because it continues to grow at a very high rate, is extremely profitable, and we desire to be a bigger part of our mix.

So things are going well there and we don't think that's going to change anytime in the future..

Got it. And maybe just one last follow-up on the share buybacks. And sorry if I missed this, Fabio.

Did you mention if there was any guide on 2019 CapEx and leverage targets as it relates to this new news?.

No. For 2019, we expect to be in the same range in CapEx as of this year. We have a very dedicated team and we focus on fast payback opportunities and we have 12 months' window to do the share buybacks..

Got it. Thank you..

Our next call comes from Adam Samuelson with Goldman Sachs. Please go ahead..

Yes, thanks. Good morning, everyone..

Good morning..

Good morning..

Maybe talking a little bit more on the market environment and I guess this is a continuation of Ken's line of questioning. Just as we think about the go-forward on the industry, I mean, the big bird deboning industry is in the red right now. And I presume your own business within the U.S.

is you're not making money in that market segment and, certainly, it wouldn't be in the fourth quarter given current pricing.

What would it take, in your mind, for the industry to actually cut back production given the seasonal factors that are ahead in the spring and the new plants? So just I guess the concern that I think is growing is this year has been more of a demand problem than a supply problem and a supply problem more on the competing protein side.

Chicken supply growth this year has been fairly benign by historical standards and if the demand environment does not improve as rapidly as you might hope, with the new processing plants in the industry, that stuff's pretty locked in.

So just help us think about kind of that segment profitability today and how that might change if you don't see that pick up in feature activity in retail and foodservice that you're expecting..

The way we think about it, Adam, is, in fact, to go back to the root cause of what caused the decrease in demand this past year, and that being lack of feature activity due to higher supplies of pork and beef and then the trade issues that in part caused that. We believe that the trade impact is going to lessen into 2019 due to a couple of things.

One, we've been monitoring this sort of global outbreak of African swine fever and its potential impact on the swine herd size in Europe and in Asia. We think that given what has occurred so far, that could provide meaningful lift in demand for U.S. pork around the world, therefore, clearing more supply here in the U.S.

We don't think beef supplies will grow as much in 2019, as they did year-over-year in 2018 and see a decent export environment for beef. And then given the break, if you will, that retailers and foodservice operators have taken in chicken promotions, we think that we'll see more feature activity in chicken in 2019.

So a little bit like we saw coming out of 2016 and 2017, we think that that same environment may persist 2019 versus 2018 and therefore see an increase in demand for chicken. Now for Pilgrim's, we're not solely relying on that to improve our own margin structure. And so to mitigate that not happening, as you mentioned, we're doing several things.

We're growing our branded business, we're growing our Prepared Foods business, both of which are more stable in margin.

And as I mentioned in the prepared remarks, we're converting another large bird deboning plant to a small bird segment, much like we did when we converted our Sanford, North Carolina plant out of that and we saw a significant improvement in margins so – and it's not a small number.

I think the plant that we're converting is about 10% of our large bird deboning capacity, much the same as Sanford was when we converted that. Now I'll hurry on to say that we think the large bird deboning business long-term is a great business to be in. It's been among the most profitable segments of the chicken business in the U.S.

for many years and I would just point you to Q3 of 2017. It was a significant margin contributor and we think that that business at some point in the future will return to being a great profit contributor, so we remain committed to that segment..

Just in terms of capacity expansion, Adam, you mentioned the increase in production. Our expectation is a 2.8% to 2.9% increase in 2018 and there is one new plant in the big bird segment being built. We believe that this increasing supply is adequate if everything that Bill mentioned is in place..

That's helpful. And then, just on the demand side for the retailers, have you seen any evidence that cheap chicken features, whether it's $0.99, or $1.29 breast meat, or $0.69 leg quarters are actually kind of converting into traffic? And some of the anecdotes that we hear from retailers, it's just that it really hasn't taken hold.

And I guess the worry I'd have is if we're looking at the summer and the experience on chicken features is they don't drive incremental traffic, that chicken breast is fighting for case base with a red meat product that carries a notably higher price per pound.

So it's not driving traffic if the retailer really going to sub in a lower value, sacrifice those top line dollar sales..

Well, I can speak to our retail business with our key customers and we continue to see growth with our key customers; as a matter of fact, fairly robust growth. And we're planning to continue to grow our tray-pack operations and case-ready operations in order to keep up with demand for all those retailers.

I think perhaps one thing that differentiates us from others is our key customers happen to be those retailers who are growing the most, and so that helps our own. And in terms of the greater market, I couldn't really comment on that..

Okay. And then, just a question just on Moy Park. As we look forward, I mean, you increased your confidence in the synergies that you can achieve there. Year-on-year, the profit was up.

Was there any impact in the quarter from the elevated feed costs that you've seen in Europe or will you be able to price that all through it in the period or does that come through with a lag so that the year-on-year profits look better as you (00:50:10)?.

Yeah. There is a lag in price recovery from feed ingredient inflation. But I'll tell you, our team did a great job of getting in front of customers and recovering as much as we could. And Fabio can give you the increase in feed cost for the quarter for Moy Park.

But again, I believe our team did an outstanding job in recovering most of that cost, and we'll continue to do that as higher cost comes through. And we've also employed our key customer strategy in those markets, and that's working well in addition to that, enabling us to recover that inflation.

I would also remind you that the inflation has not only come from feed ingredient cost increases, but also labor costs and utility costs have gone up there as well, and we're talking to our key customers about those increases also..

Okay, great. That's all very helpful. I'll pass it on. Thanks..

Our next question comes from Akshay Jagdale with Jefferies. Please go ahead..

Hi. Good morning. This is actually Lubi filling in for Akshay. Bill, I believe in your prepared remarks you mentioned that despite some indications of improving productivity of the breeders that you believe that the new generation of birds will remain less productive than the previous generations.

I was wondering if you could just elaborate on that a little bit, why shouldn't we expect those productivity trends to continue to improve given that all else equal that would be beneficial for the industry over time?.

Lubi, I'll give you actually what we've seen happen with the flock size and the productivity of that flock. So we saw the breeder flock size increase by 3.2%, but we sell eggs per hundred. Hens decreased by 1%, and therefore eggs produced only increased 2.1%. We had a fertile egg export of 3.1%, a hatchability decline of 0.7%.

And so, chicks per hen, which is really at the end of the day, the critical number, the number of chicks per hen year-to-date declined 1.7%. So even though we continue to place more pullets as we continue to change this breed mix that we have in the U.S. at least, we continue to see productivity on a per hen basis go down.

And so that's what's causing the need for placing more pullets in order to maintain the same number of chicks placed for broiler production. So those are the numbers. That's what we've been seeing the last three years.

And we don't see any change in that as we believe this is a structural change based on choices of breeds that we and our peers have chosen. And we do that because we get better feed conversion and we get better yields from the new breed..

An, of course, Lubi, as the productivity improves and if, we will adapt the size of the breeding flock for the number of eggs that the industry require to do its production. I'll remind you that today we are operating at a very high operational level, both in the hatcheries and at the plants..

And we've actually just recently seen an increase in hen slaughter, so what that tells us when we see an increase in hen slaughter, we're bringing down the age because that productivity is improving, so we can alter the inventory of those hens in production by killing them sooner or at a younger age and manage the productivity that way..

Got it. That's helpful.

And maybe just as a follow-up to that, where do you think the industry is in terms of this sort of breed shift? Is there still much more to go or are we sort of at the tail end of that?.

I think there's more to go. It started in the big bird deboning category but it's also now worked its way into the medium-size bird and even small bird category where breed choices are changing based on productivity and yield.

And we're now making breed selection choices in our small bird segments different than we've made in the past and we're seeing the same result..

I'll just say that this is a very evolving structural change but it doesn't mean that we will not change again in the future. We always strive for the best profitability and that depends on feed conversion, on meat prices, on feed costs. So we're always moving to a better breed as it is available to us..

And that's a good point. Quite frankly, we've learned some things based on our experience now in the UK and Europe that we're – we've made some changes here in the U.S. because of that. And so we think that's again a competitive advantage for us..

Got it. And maybe if I could ask one more question. I was just wondering if you could comment a little bit on how you're thinking about M&A opportunities in the near term.

I'm just wondering if the announcement of this share buyback program is maybe an indication that M&A opportunities in the near term are fairly limited or maybe not quite as attractive as you would have liked?.

We're focused on growing and I think the growth that we desire is that which improves our portfolio balance. And so, we don't see a change in that. We gained authorization from our board to repurchase shares really again as a tool to increase shareholder value and we have that tool available to us.

But if we find an acquisition that we believe is very accretive from both an overall margin standpoint and our portfolio balance standpoint and I can assure you we're going to be pretty aggressive toward it..

Yeah. We consider ourselves prudent acquirers and we have the balance sheet strength to pursue any opportunity as they come..

Thank you. I'll pass it on..

This now concludes our question-and-answer session. I would like to turn the call back over to Bill Lovette for any closing remarks..

Thank you. We believe our diverse portfolio of differentiated products and key customer strategy will continue to generate a more resilient performance and minimize margin volatility compared to our peers despite individual market conditions. We remain positive on the outlook for chicken consumption globally. Despite the challenges in the U.S.

commodity sector, we believe chicken continues to be the most compelling protein everywhere around the world. We'll continue to identify new opportunities including Europe both organically and through acquisition to refine our portfolio and offer differentiated customized products while pursuing our key customer strategy.

We'd like to thank everyone in the Pilgrim's family as well as our customers and always appreciate your interest in our company. Thank you all for joining us today..

The conference has now concluded. Thank you for attending today's presentation and you may now disconnect..