(Debtwire) Boparan cost spike erodes earnings on pass-through time lag, as third parties provide feed support

29 March 2021 | 18:03 BST

Boparan’s latest results were weak, as rising feed costs cut margins. Management is confident rising costs can eventually be passed through increased prices with a three-month time lag, but any further delay could mean more operational weakness ahead. This makes the risk-reward on its recently issued B3/B-/B rated GBP 475m 7.625% senior secured 2025 bonds look uninspiring for two buysiders and two more deep-dive analysts.

The UK-headquartered poultry producer reported 2Q20/21 results for quarter-end 30 January on Wednesday (24 March). 2Q20/21 reported EBITDA was down 57.6% Year-on-Year (YoY) to GBP 12.8m while like-for-like (LFL) EBITDA fell 49.1% YoY to GBP 13.9m with LFL EBITDA margins reducing 230bps YoY to just 2.2%.

Management on the earnings call explained that the reduced earnings were driven by feed cost inflation timing, COVID headwinds, extra Avian influenza issues and Brexit disruptions. They noted these four headwinds combined generated “the perfect storm.”

Positively, weak results should not repeat given most of feed pricing ratchets have a three-month time lag, whereby increased costs can then be translated into increased prices for Boparan’s products, preserving margins.

CLICK HERE for the 2Q20/21 earnings call transcript.

“They need to increase prices [and] can do that effectively maybe with a three-month lag," one buysider said. However, "the [UK supermarket chain] Tescos of the world won’t accept too much of a price increase. EBITDA will also be weak in next quarter and [there will] likely to be further [pressure on] the bonds – fundamentally trading performance is going to be very weak due to the high material cost.”

Feed costs are likely to remain sustained, with management expecting such costs to reach record highs by year-end. While ratchets will recover the pricing impact in full, the time-lag will have to be accounted for. Around 80% of the rise in feed inflation can be recovered through pricing ratchets.

“The results were shocking. [London-headquartered packaging group] Kloeckner Pentaplast had the same on the plastic side. Boparan have taken on more chicken than they can chew,” a second buysider commented. “There will be disruptions and they will pass through increased costs, but it can be a year before it normalizes.”

The first buysider noted that poultry is a staple for Boparan’s business. “Feed stock prices reduced in 2020 and they kept those benefits and were able to then pass lower costs by putting lower prices to the customers across the main supermarkets,” he said. “Now, every commodity cost is soaring, their cost is going up, but prices are flat, generating less profit per chicken produced.”

Management explained that the reduction to GBP 13.9m in 2Q20/21 LFL EBITDA from GBP 29.4m a year back is down to a GBP 7m impact from feed recovery timing, a GBP 5.4m COVID sales impact, GBP 0.9m COVID volume transfers and a GBP 2.1m COVID operational impact (see chart below for bridge from company presentation).

Boparan remains hopeful earnings can improve. The company marketed its November bond refi with 3.3x net leverage based off a GBP 134.8m pro forma run-rate adjusted EBITDA, suggesting there could be some upside if feed costs are under control. The new Turnaround Program initiatives and measures to reduce fixed costs should also help improve margins in the long run. Management noted there has been a GBP 31.5m negative impact from COVID on LFL EBITDA over the LTM 2Q20/21 period.

In 3Q20, before the refinancing, the company was talking about a pro forma run-rate EBITDA of GBP 153m while 2Q20/21 LFL LTM EBITDA is down at GBP 96.9m, independent deep-dive research firm Everest Research pointed out. Taking into account GBP 32m of LTM negative COVID impact on top of the GBP 97m LTM LFL EBITDA brings to GBP 129m, then adding back the feed cost impact in 2Q20/21 of GBP 7m gets you to GBP 136m, Everest calculated. But it is hard to see what is the net COVID impact as the pandemic has some positive impacts too, on stockpiling and eat-at-home being boosted, they added.

Bo-subpar-an

Metrics are now higher versus at bond launch. Reported net leverage for the company was 4.8x at 2Q20/21 versus 3.3x pro forma its November refinancing based on LTM 1 August 2020 pro forma run-rate financials. Adjusted 2Q20/21 metrics climb to a more cumbersome 7.1x including a GBP 218m pension deficit, according to Debtwire analyst calculations.

Deleveraging in the near-term looks unlikely given the recent fall in earnings. With a 2Q20/21 LTM LFL EBITDA of GBP 96.9m, the company could face around GBP 50m capex, GBP 36m interest, GBP 4m cash taxes, GBP 23m annual pension payments and GBP 10m of non-recurring items according to analyst estimates at its roadshow. This would mean negative GBP 26.1m of free cashflow. The company for the fiscal year expects a small working capital inflow on an underlying basis.

As a result, its liquidity position could reduce in the near-term unless earnings recover. Boparan ended the quarter with a GBP 39.2m cash position, having drawn GBP 23m of its GBP 80m revolving credit facility. The facility can be increased to GBP 90m but has a quarterly minimum EBITDA test of GBP 75m.

The notes share collateral with the initial GBP 80m RCF, but the GBP 90m credit facilities basket (including the GBP 80m RCF) and certain priority hedging have super priority over the notes with respect to collateral enforcement proceeds, according to a report from Xtract Research, a Debtwire sister service.

The company relies on factoring with an end-January factoring position of GBP 74m from customer platforms and a GBP 64m receivables finance factoring.

There are far fewer assets they can sell going forward but the business has significantly de-risked versus 2017-2019, according to Everest Research. The key de-risking components have been the introduction of c80% feed cost pass-through into customer contracts, replenishment of reduced lower margin volume from Tesco with higher margin volume elsewhere, cost savings through facility closures and other productivity measures and pension deficit reduction through contributions made. “Volatility in the bonds may be desirable also for Mr. Boparan, who might enjoy the chance to buy back bonds cheaper as he may have done with the previous SSNs,” Everest added.

Further disposals will be considered when the time is right, but the timeframe for this will more be one to two years, management said on the earnings call.

From Range to Ranjit trading

According to Boparan’s bond prospectus, the poultry business is vertically integrated through Hook 2 Sisters, which is a joint venture with PD Hook. Hook 2 Sisters supplies over 95% of all live bird that is needed for Boparan in the UK to 2 Sisters Food Group, a wholly owned subsidiary of Boparan Holdings Limited (see chart further below for group structure from bond prospectus). In addition, 2 Agriculture Limited, a related party non-group company, supplies 40% of the total feed for live birds required, which Hook 2 Sisters then supplies to Boparan.

Management noted on the earnings call that purchases from its unrestricted group entity Hook 2 Sisters is not such a good cost of sales proxy for the UK poultry business as packaging costs and buying meat costs also need to be part of the equation.

Management added that up to 7 million birds could be killed with the process cycle from parent stock to hatcheries and space on farms taking a couple of months. This process for sourcing feed includes an investment from outside of the restricted group that is owned by the shareholder, meaning Boparan Holdings Limited as a business do not need to fund it, which is advantageous.

Everest Research noted that Hook 2 Sisters is a 50:50 joint venture between PD Hook (supplier of chicken) and 2 Sisters Food Group, and the feed for Hook 2 Sisters is provided by 2 Agriculture (around 45%) and third parties (over 55%). 2 Agriculture is owned by Mr. Boparan (through Amber REI Holdings Limited) and the investment at 2 Agriculture to support higher volume does not require direct funding by the BHL Restricted Group, though it is unclear to what extent the restricted group may end up paying for this investment indirectly through higher feed prices.

“It is also unclear to what extent pricing of feed supplied by 2 Agriculture to Hook 2 Sisters is aligned with pricing of feed supplier by unrelated third parties and to what extent there is any difference in Boparan's ability to recover (from its customers) any higher cost (if any) paid for feed from 2 Agriculture vis-a-vis Hook 2 Sisters' other suppliers,” Everest pointed out.


They invest in their own capacity, but it is uncertain how this is financed, the second buysider concurred. There is financing outside the restricted group and capital is not free, he added.

“Feed prices and some other costs are a complex issue for Boparan given how feed runs through the structure before entering the consolidated group,” independent special situations firm Sarria said. “Like a hot air balloon, Boparan have time and again raised their earnings into a refi, just about made it, only to drop off again afterwards. We exited through the refinancing and wouldn’t touch it here again.”

Boparan’s B3/B-/B rated GBP 475m 7.625% senior secured 2025s lost a half point since the results to be indicated today (29 March) at 98.75-mid yielding 7.9%, though the bonds dipped as low as 97.75-mid last Wednesday, according to Markit.

“Even though we had been long the name for most of last year, we [were] more than sceptical on just how long the run would last. Chickens don’t fly and neither does Boparan,” Sarria commented. “Last year Boparan was one of our favourite fundamental trades, but part of this was probably borrowed from the future in terms of who pays for what and when along the supply chain.”

This was a weak quarter, but the problems should not recur, according to the second buysider. However, "the bonds are expensive but [French-headquartered sugar producer] Tereos was shorted and then they refinanced. This is an expensive short and one needs conviction,” he said. “The management team have delivered on everything they promised two years ago, and people did not believe they’d do it.”

Boparan declined to comment.

by Adam Samoon and Michal Skypala