Boparan - timing is art of delivery.
All,
Please find our updated analysis here
We are wearily familiar with the challenges that Boparan faces in its relationship with its customer base. The recovery of previously incurred inflationary costs in Fiscal Q3 has supported the liquidity position of Boparan. Long term we need to see a pricing system that is: 1. Comprehensive and 2. Timely. The urgency here is only exacerbated by the impact of the war in Ukraine on costs, as price rises flow through to consumers and there will be some volume drag as consumers balance the higher cost of their weekly shop against the absence of cheaper protein sources.
RCF Covenant met:
- Meeting the covenant secures continued access to the RCF. The repayment of £20m of drawings in the quarter underlines management's confidence of compliance in July.
- There was £2.5m headroom, with compliance in July needing EBITDA of >£23m in Q4.
- LTM EBITDA was £77.5m (adjusted for the Uttoxeter facility, which was outside the Restricted group). Management expects to increase the £2.5m headroom in coming quarters.
- The RCF is £35m drawn currently (£45m headroom).
- We expect a further pay-down of the RCF as receivables outflows reverse in Q4. Vs. our previous model, Boparan registered a large Q2 outflow of £20m, which management attributes to a mix of inflation and seasonal movements. Looking back, we cannot find much seasonality to support the latter half of the statement, so we conclude it has to do with inflation - I.e. supermarkets are buying at higher prices but are paying according to their budgets - or something of the kind. However we do accept that management expect these outflows to reverse and are forecasting a £30m inflow in Q4 as these impacts reverse. For the year overall we are modelling a working capital outflow of £23m. This will include a £10m increase related to the disposal of the Uttoxeter facility.
Faster pass-through of inflation is happening:
- Boparan claims to now have 92% of feed costs subject to monthly ratchets, which should minimise the time lag that has hurt cash flow over the last four quarters.
- £38m of EBITDA is proof that price rises are being achieved, but the length of the détente with the supermarkets is unknown. In the meantime, the Boparan can expect greater resilience in their gross margins.
- The swingeing price rises in feed and power early in calendar 2022 finally provided the impetus required to reduce the time lag in recovering inflationary cost rises and passing them on to consumers.
- Utility, fuel, and labour costs are still part of the contract negotiation, there will still be some lag, but it is a fraction of the feed cost issue, and the costs are still recovered. This will need monitoring.
- EBITDA £38m (vs our forecast of £43m). The EBITDA margin of 5.3% is almost at the 5.5% used in the bond prospectus in 2020. Additionally, Q4 margins will be boosted slightly by other non-feed cost recoveries.
- Anecdotal evidence points to these higher prices being passed on to consumers.
Higher prices beginning to impact volumes:
- Higher prices will crimp volumes at the margins, but mostly this will be recovered by improved sales to discount supermarkets. Chicken is a cheap form of protein, but it is not immune from price elasticity.
- Management said that they are already seeing some softness at the premium end of the market with some balancing improvement at the discounters. Management rarely comments on volumes so no additional detail was provided. The impact on EBITDA will be modest but will remain over the next 12 months.
- Falling sales of ready-to-eat meals is another impact and they expect some volume and margin pressure in the Bakery business over the next 12 months.
- Between November and March Avian Influenza removed some supply from the European market helping underpin prices. These birds are returning and the bounce back in supply will hurt prices at the margin.
Investment Rationale
- We remain long 5% of NAV via the Dec 22 CDS last year, before the Ukraine war began. We had expected that Q3 would be strong and the RCF covenant would be met. Management is expecting a strong Q4 on the back of further inflationary cost recovery from 2021 and the operation of the new monthly pass-through contracts. This would only leave the October 22 quarterly test before our position expires. The October quarter reports in January.
- The next Fiscal year is likely to see some headwinds in Q3/Q4 with tougher comps but also the impact of higher prices on volumes.
- If the relationship with the supermarkets remains supportive Boparan will be largely shielded from input cost inflation. Bird supply is rising as the farms shut during the Avian Influenza outbreak return to production, this is impacting European production more than the UK. A rise in supply and the impact of the cost-of-living crisis on consumer spending will hurt volumes marginally in the next 12 months. Volumes are falling marginally as the cost-of-living crisis impacts consumer spending.
- We have tweaked our model to reflect greater confidence that cost pass-throughs will continue to be made quickly and more fully and will reflect in a stronger Q4.
- We expect 2022/23 to see some volume attrition however we are growing more confident that the relationship with the supermarkets is now healthier. Once we have a better view of the volume impacts, we will review whether we are comfortable with a long position in the bonds. I look forward to discussing this with you all.
Regards,
Aengus