Kerry refuses to do the splits
Kerry Group is determined to retain its consumer foods arm in spite of falling margins and a €17m Brexit hit, writes Dan White
THE cost of preparing for Brexit was one of the main contributors to an 8pc fall in after-tax profits at Kerry Group as the company prepares for Britain’s possible no-deal exit from the EU. Kerry Group, Ireland’s largest quoted food company, unveiled its 2018 results last Tuesday. The results were broadly in line with market expectations with a 3.1pc increase in sales to €6.6bn while trading profits were also up 3.1pc to €805m. Volume growth was slightly higher, about 3.5pc, reflecting price deflation brought about by lower raw material costs.
For Kerry boss Edmond Scanlon the highlight of the results was a 8.6pc increase in adjusted earnings (basically after-tax profits) per share in constant currency terms to €3.53.
Unfortunately, when adverse currency movements are taken into account, the gloss comes off the Kerry results — with the increase in adjusted EPS falling to 3.6pc. Add in a number of one-off charges and basic EPS actually fell by 8.3pc to €3.06. Kerry took a €67m hit, of which €17.3m went to cover possible Brexit-induced losses at its consumer foods division, which is heavily exposed to the UK market.
Between the jigs and the reels, despite the increase in sales and trading profits, Kerry’s after-tax profits actually fell by 8pc to €540m in 2018.
“A solid steady set of results,” is how Investec analyst Ian Hunter describes the numbers.
The Brexit-related charge has once again focused attention on Kerry’s disparate collection of businesses. These are its taste and nutrition division and its consumer foods arm. Taste and nutrition produces flavourings and ingredients for food, beverage and pharmaceutical companies while consumer foods mainly supplies British and Irish retailers with dairy and meat products.
Apart from sharing a common parent, taste and nutrition and consumer foods could hardly be more different. In 2018 taste and nutrition sales grew by 4.1pc to €5.35bn and trading profits increased by almost 5pc to €805m . By comparison consumer foods sales increased by less than 1pc to €1.34bn while its trading profits fell by 7pc to €100m — head office costs and double-counting resulting from intra-company transactions came to almost €100m to give a total group trading profit of €805m.
While taste and nutrition had trading margins of 15.1pc in 2018, up from 14.9pc in 2017, consumer foods’ margins fell by 0.6pc from 8.1pc to just 7.5pc. Put it another way: taste and nutrition contributes 81pc of Kerry’s sales and 89pc of its trading profits while its sales are growing more than five times as quickly as those of consumer foods.
Which inevitably begs the question: why is Kerry still persisting with its legacy consumer foods business? At the end of December 2018 consumer foods’ gross assets were valued on the Kerry balance sheet at €938m. Surely this is capital that could be redeployed into the more profitable and faster-growing taste & nutrition businesses?
In 2018, taste and nutrition’s trading profits were the equivalent of 15.8pc of its average gross assets while consumer foods’ trading profits were the equivalent of just 10.6pc of gross assets. Reallocating the capital tied up in consumer foods into taste and nutrition has the potential to lift Kerry’s annual trading profits by almost €49m.
And there is a precedent. Glanbia, which also reported its 2018 results last week, hived off its Irish dairy-processing business to the farmer-owned Glanbia Co-op in 2017. The new company, Glanbia Ireland is 60pc owned by Glanbia Co-op with Glanbia PLC owning the remaining 40pc.
However, converting the legacy businesses back to co-op ownership is an extremely fraught process — as Glanbia can testify. An earlier attempt to hive off its Irish dairy-processing businesses to the Glanbia Co-op failed in 2010 when the proportion of co-op shareholders voting in favour of the transaction fell marginally short of the legally-required 75pc.
One possible trigger for Kerry hiving off its consumer foods arm might be the option held by Kerry Co-op, which still owns 14pc of Kerry Group PLC, over Kerry Group’s agribusiness division, which must be exercised by 2020.
While the agribusiness division represents only a small proportion of consumer foods operation, would a move by the co-op to bring it back under farmer ownership be the opening gambit in a wider corporate restructuring?
What is indisputable is that the market reaction to what was widely seen as a set of so-so Kerry results was underwhelming. After closing at €91.40 on Monday, the shares jumped by 2.7pc to €93.90 in the first couple of hours after the announcement. They quickly fell back after that and were trading at about €91.40, ie virtually back to their pre-announcement level, by the end of the week.
The market response to the better-than-expected Glanbia results was much more positive with the shares jumping by over 10pc to €18 in the first few hours after the announcement. Unlike Kerry, Glanbia shares held to most of their post-announcement gains and were trading at €17.85 at the end of the week.
While a spin-off of consumer foods would undoubtedly play well with Kerry Group shareholders it might struggle to find favour with Kerry Co-op shareholders. The Kerry Co-op board has discussed whether or not to exercise the option before it expires. The co-op board has also consulted with its members on the topic. However, only 307 of the 1,507 co-op shareholders
Reallocating the capital tied up in consumer foods could lift profits by €49m
who responded to the survey were in favour of exercising the option.
With 67pc of co-op shareholders needing to vote in favour, the support for such a deal may not exist. The campaign by the Kerry Co-operative Shareholders Alliance, which represents some co-op shareholders, for the co-op to ‘spin-out’ all or most of its remaining Kerry Group PLC shares also doesn’t augur well. However, the biggest obstacle is almost certainly the determination of Kerry Group to hang on to consumer foods.
“Kerry has long had a successful dual strategy for growth and return on investment and our deep dairy heritage has significantly benefited both businesses,” says a Kerry spokesperson.
“Our strategy is to invest and grow globally while maintaining that strong dairy heritage and connection with our home markets. Our world-leading innovation capabilities deliver optimum responsiveness to the significant opportunities and challenges that arise and afford us a clear advantage in both businesses.”