Upfield - Not all leverage is the same
All,
Please find our updated model here.
We took our initial 2.5% position in mid-August post-Q2 numbers at 62% and increased our position in December at 72% to 5% long. We are maintaining our position at the current 15% yield, and remain confident that further deleveraging is ahead. Headline leverage is high at 7.0x and the relatively small size of high-yield bonds (1.5x leverage) is a worry for some investors. Gross profit margins were at 34% for FY22, still lower than 40% and 38% in FY19 and FY20 respectively. But improvement continues quarter on quarter, with H222 margins hitting 36%. Underlying elasticity remains in the -0.2 to -0.3 range, with sales growth of 18.5% driven by 29% increase in pricing. In fact, price increases more than compensates volume decline and commodity and logistical inflation. Gross profit has recovered across all regions.
Recent Results:
- The FY22 was a non-event, with the Company beating its guidance. Apart from the normal lecture on the virtues of plant-based products over dairy products, the management did highlight the strength of their brand portfolio and the elasticity of their product. At a group level, volumes/mix were down c.10% for FY22 which was more than offset by c.30% rise in prices. The underlying volume decline, excluding Upfield’s actions of removing SKUs, was down 6.5%.
- We had viewed the guidance from the Company of year-end leverage of 8.0x to be conservative as it turned out (7.2x) and we continue to expect leverage to end FY23 below 7.0x. The Company declined to give specific guidance but the general tone of the call was for more deleveraging.
- The relative pricing of Upfield’s products versus Butter is maintained in the 1.8-2.0x range (plant-based is cheaper than dairy products), making it easier to push through price increases as demonstrated by the results.
- Commodity/energy risk has not disappeared but Upfield continue to hedge its exposure in vegetable oils and energy markets.
- As previously commented, during February Upfield reduced their Term Loans by c.€250m.
Outlook:
- As stated above, Upfield has not provided any specific guidance for FY23. However, they confirmed they are likely to maintain the recent trajectory for deleveraging and we reiterate our confidence of sub 7.0x leverage by year-end and c.6.0x by FY24, in time for a refinancing of the Term Loans which fall due in July 2025.
- Our model projections of c.6.0x in FY24 are based on the elasticity of demand Upfield has shown over previous quarters coupled with the €300m of cost reductions achieved by Upfield’s cost-saving plan since 2019. The relative price differential versus butter has maintained over the last year, providing further comfort to our projections. We do not model for Upfield to regain lost volumes but early indications show this may be a further upside.
- We have previously stressed and tested the cash flow, and it must be acknowledged that despite the reduction in Gross Profit margins to c.20% the business will remain cashflow neutral to marginally positive.
Recap on KKR ownership:
- Upfield raised the debt on a pro-forma €820m in FY17 which it has never achieved. Additionally, Upfield has seen no meaningful debt reduction since inception, albeit in February 2020 drew down a further €375m for the Arivia acquisition.
- However, the deal pro-forma adjustments were aggressive, with actual EBITDA in FY17 being c. €674m. For reference, FY22 EBITDA is c.€750m, the highest actual EBITDA achieved since the spin-off from Unilever. Additionally, the management has transformed the business significantly with a significant reduction in SKUs and the introduction of new products.
- FY23 and FY24 are important years for deleveraging and it is fair to say Upfield has decent momentum on both pricing and cash generation from recent quarters. We expect a further reduction in leverage over the coming quarters.
Refinancing:
- With just over two years to the maturity of the Term Loans in July 2025, refinancing risk is starting to fall into view. We acknowledge a refinancing of the capital structure is more expensive in the current environment with base rate movement accounting for at least €100m additional interest bill.
- Coupled with the above the fact that the limited deleveraging since inception, reconfirms the next couple of years are important years for deleveraging. We had previously feared further acquisitions by management but we sense a change in tone recently and the focus is now solely on deleveraging.
- We expect FY23 and FY24 leverage to end at 6.2x and 5.6x respectively, making a refinancing in FY24 achievable.
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk