Strategic pricing challenges from a buyer s perspective

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1 Strategic pricing challenges from a buyer s perspective A Cluster Partner Fish Pool / DNB Brussels Seminar, 24. April 2017 Dag Sletmo, dag.sletmo@dnb.no, tel

2 DNB Bank is a global seafood player 2

3 DNB sells salmon price forwards via Fish Pool ~30% market share Some benefits of trading through DNB: Eliminates capital tied up as collateral with the clearing house DNB market share at Fish Pool No margin payment of mark to market simplifies liquidity management and reduces administration 25% 29% 34% Simplified documentation Possible to hedge salmon price in EUR, USD and other currencies Client maintains direct dialogue with Fish Pool 0% 6% 7% Source: DNB

4 Agenda The normal salmon price Volatility and the value chain perspective Hedging strategies 4

5 The salmon price has sky rocketed Current level ~100% above average Norwegian salmon price reaching new highs Source: SSB, DNB 5

6 Famous last words: «this time is different» But sometimes things actually are different 6

7 A farewell to the traditional cyclical pattern A new dynamic and an end to the traditional cycle 7

8 No growth = no «pork cycle» Global supply of Atlantic salmon CAGR : 10% CAGR : 2% Source: Kontali, DNB 8

9 New «normal» salmon price = NOK/kg 40+ To get 8% return on invested capital after tax, a Norwegian farmer needs NOK/kg 10+ EBIT-margin. Given cost of ~30+, the price must be 40+ Norwegian salmon price, NOK/kg Actual salmon price New «normal» salmon price? (NOK/kg 40) Cost is currently higher than NOK/kg 30 which points to a higher price than 40. And as long as supply is restricted, the price should also be above the equilibrium 16-year average (NOK/kg 33) Source: Kontali, DNB 9

10 What sets the global price long term? Norwegian cost plus return on capital Cost drives price longer term As the industry has approached full capacity utilization the last few years, the industry has moved from covering cost of capital to earning super profits Source: Directorate of Fisheries, DNB. Price and cost are WFE, not GWE 10

11 New technology needs high prices At least right now.. Potential global supply curve Source: Nofima, Kontali, DNB Hence new technology will not be built out on a large scale unless prices stay strong. Large expensive structures with long life spans but not requiring licenses could lead to long investment driven cycles ala shipping 11

12 The consumer has other choices, there is a limit to how high the salmon price can fly.. Salmon price not out of whack yet. USD/kg Salmon Beef Chicken Pork Source: Index Mundi, DNB Salmon high in the trading range vs pork, ok vs chicken, ok vs beef

13 ..but can we really speak about the salmon price anymore? NOK/kg salmon price at Kiwi, Norwegian discount retailer 368 Four products on the same shelf at my local discount retailer First Price private label Frøya mid loin Frøya sashimi Salma 190 Source: DNB 13

Demand to become more important in forecasting prices A challenge, we know way more about supply than demand Price trends Supply; we drown in data

14 Demand to become more important in forecasting prices A challenge, we know way more about supply than demand Price trends Supply; we drown in data Demand; the dark side of the moon May tilt the information advantage away from the salmon farmers towards the buyers who are closer to the end market 14

15 Agenda The normal salmon price Volatility and the value chain perspective Hedging strategies 15

Thoughts on volatility from 2013 What has happened since then? The future lower salmon price volatility? The high volatility of the salmon price is not good for the industry. Will it ever change? 1.

16 Thoughts on volatility from 2013 What has happened since then? The future lower salmon price volatility? The high volatility of the salmon price is not good for the industry. Will it ever change? 1. Lower volatility in supply growth if the industry is close to full capacity utilization from a licensing and/or sustainability point of view? 2. Stronger salmon market penetration and distribution of fresh prepacked filets at discount retailers give higher price elasticity of demand and hence more stable prices? 3. Salmon farmers integrating downstream in combination with end consumer brands lead to more stable retail prices, which feeds back to more stable whole sale prices? 4. Fish Pool reaches the tipping point? Source: Dag Sletmo s presentation at Fish Pool X-mas seminar December

17 1) The volatility of global supply growth has declined Standard deviation in global yoy supply growth, 12m roll Source: Kontali, DNB

18 2) Hard discount penetration has increased....but we don t see higher price elasticity in the numbers yet Source: Norwegian Seafood Council, MHG 18

19 3) Downstream integration continues Retailer relationships & brand focus Source: MHG 19

20 ) Fish Pool has not reached the tipping point yet.. Fish Pool volume, tons (000s) No tipping yet Source: Fish Pool 20

21 4)..but the fixed price contract share of the market has! Estimated contract share, Atlantic salmon, Norway Estimated contract share, Atlantic salmon, Norway Adding Fish Pool contracts, brings the fixed price share of the market above 50% Source: Kontali

22 Quiz; why does the Norwegian Gov t continue to issue debt when it doesn t need the money? Gov t wealth fund almost 20x larger than Gov t debt Nowegian Gov't Oil Fund 7956 NOKbn Norwegian Gov't debt -476 NOKbn The answer: The relevance of the quiz: The industry should use Fish Pool in addition to bilateral contracts. It gives a reference point and transparency in the market. Source: Norges Bank 22

23 Percentage of total Why has the fixed price share increased? A high level is the natural state of affairs Long term contracts or vertical integration Typical age at slaughter: 5-7 weeks Typical age at slaughter: 6 months Typical age at slaughter: 36 months Chicken Pork Beef Spot and auction markets are a limited part of US and EU meat sectors Source: FAO, Ragnar Tvererås (Barkema, Drabenstott, Novack)

24 Why did it take so long? A young industry & long value chains Agriculture Farm Regional transport Packaging/ VAP National transport Salmon farming Farming Local transport Harvesting/ fillet International transport Fillet/ VAP National transport End buyer Wild catch fishing Fishing vessel Fish landing International transport Importer/ wholesale National transport Fillet/ VAP National transport Source: Ragnar Tveterås Time, transaction cost

25 Suppliers must increasingly adjust to end customers The past Price Price Farmer Processing company End customer Volume Volume Now Price Price Farmer Volume Timing Processing company Volume Timing End customer Quality Quality Source: Ragnar Tveterås

26 Has volatility dropped? Yes, but not all that much. Room for further reduction Salmon export price volatility Source: SSB, DNB 26

27 Spot price volatility dropped less than export price High contract share has reduced the available spot volume..which has helped propel the spot price above the export price Spot price (Nasdaq) premium/discount to export price (SSB) Source: Kontali, SSB, Fish Pool, DNB 27

28 Agenda The normal salmon price Volatility and the value chain perspective Hedging strategies 28

29 Why hedge? Smooth earnings - Happier owners, higher valuation of company More important for farmers than earlier as the investor perception has changed from cyclical commodity play to secular growth focus Operational focus - Large earnings swings driven by market prices can be demotivating for employees and an organization which works hard every day to make money on regular operations Reduce risk of financial distress - Lack of liquidity, breaking loan agreements, bankruptcy But it is really earnings you want to hedge, not cost! 29

30 Implications of the tipping point: Go with the crowd! If you are a price setter hedging the raw material price reduces earnings volatility If you are a price taker you should follow the hedging strategy of you competitors in order to reduce earnings volatility (don t hedge if they don t, do if they do) - What the majority does will set the market price - Things even out over time, but the pain in the mean time can be brutal and you may need a very strong balance sheet to ride out the storm Source: DNB Markets 30

Airline example Fuel is to an airliner what the salmon price is to a salmon processor The ticket prices track the fuel price closely; but with a one year time lag Increasing fixed price share in the

31 Airline example Fuel is to an airliner what the salmon price is to a salmon processor The ticket prices track the fuel price closely; but with a one year time lag Increasing fixed price share in the salmon market may create a longer lead time from changes in the salmon wholesale price to changes in retail prices Ticket prices (yield) track fuel prices with 1 year lag Impact on earnings from hedging raw material cost Does the company hedge? Yes No Does the industry overall hedge? Yes No Stable Unstable Unstable Stable Source: DNB Markets 31

32 The force is with us! All the mega-trends in favor of the fish farming industry The road ahead, #1 Source: DNB Growing middle class in emerging markets demands more protein Better grocery retail supply chains in emerging markets An increasing world population needs food Higher educated population eats healthier Ageing population eats more fish Limited volume potential in fishing, growth has to come from fish farming Limited CO2 waste and water consumption vs other animal production Low feed conversion rate vs other animal production 32

33 Thank you for your attention 33

RISKS & DECISION MAKING

FISH POOL CHRISTMAS SEMINAR 2013 RISKS & DECISION MAKING Dag Sletmo The psychology of financial markets Neither people nor markets are completely rational Rule #1: define whether you are trading or hedging