PRICEY, SPICY... OR PALAT­ABLE?

Or­der care­fully from the JSE's food sec­tor to avoid in­di­ges­tion

Financial Mail - Investors Monthly - - Front Page -

I n good and bad eco­nomic times peo­ple have to eat, a re­al­ity that leads many in­vestors to view food com­pa­nies as safe havens. This is not al­ways the case.

Just how vul­ner­a­ble some food com­pa­nies’ prof­its can be was ham­mered home by the re­cent drought. The re­sult of an ex­treme El Niño event, it was the worst SA has ex­pe­ri­enced since 1904, when records were first kept.

SA faced a huge de­cline in maize pro­duc­tion. Prices went into or­bit, with the white maize price in early 2016 stand­ing at twice the level of a year ear­lier.

Some­what per­versely, govern­ment added more cost pres­sure in Au­gust 2016, when it in­creased the im­port tar­iff on wheat by 30% to R1,591.40/t, its high­est level yet and 10 times the level in 2014. SA im­ports about 70% of its wheat needs.

Among the com­pa­nies worst hit is Pi­o­neer Foods, which re­lies on es­sen­tial foods such as maize meal and bread for about 60% of rev­enue and op­er­at­ing profit in a nor­mal year. Maize makes up about 20% of group in­put costs and wheat about 40%. It led Pi­o­neer CEO Phil Roux to de­scribe 2016 as “a year from hell”.

SA has now swung from famine to feast, with ex­cel­lent sum­mer rains and a 30% rise in maize plant­ings set to in­crease the 2017 har­vest 75% to a fore­cast 14.5Mt, the sec­ond high­est yet.

Maize prices have fallen back to lev­els last seen in early 2015 but it will bring no re­lief to Pi­o­neer un­til maize fu­tures con­tracts bought at higher prices be­gin un­wind­ing.

The re­sult in Pi­o­neer’s six months to March was a 45% slump in head­line EPS (HEPS). It brought to an abrupt end a bril­liant growth run since Roux be­came CEO in 2013.

The fu­tures po­si­tions are now start­ing to un­wind and a profit re­cov­ery should get un­der way in the sec­ond six months to Septem­ber. The re­ally big re­cov­ery will come in the next fi­nan­cial year.

Adding im­pe­tus, the wheat im­port tar­iff was cut by 25% in Fe­bru­ary.

It is a re­cov­ery the mar­ket be­gan dis­count­ing many months ago, boost­ing Pi­o­neer to a nor­malised p:e of around 19. It leaves it look­ing fully

priced. How­ever, Pi­o­neer re­mains a share to ac­cu­mu­late on price weak­ness.

Roux is de­ter­mined to re­duce the im­por­tance of es­sen­tial foods and ramp up the group’s op­er­at­ing mar­gin by driv­ing its key gro­cery brands which in­clude WeetBix, Bokomo, Liqui-Fruit, Spekko, Ceres, Sa­fari and Pasta Grande.

In Roux’s sights is a tar­get op­er­at­ing mar­gin of at least 13.5% by the end of 2018, up from 11% achieved in the year to Septem­ber 2016.

On Roux’s out­stand­ing record, it is doable. When he took over as CEO Pi­o­neer’s op­er­at­ing mar­gin was only 4%.

Pi­o­neer has not been alone in its year from hell. As­tral, the big­gest player in the poul­try sec­tor, has had it even worse.

As­tral has been hit by a dou­ble whammy: a soar­ing maize price, its big­gest in­put cost, and ris­ing cheap poul­try im­ports which now equal more than 40% of SA pro­duc­tion. The two big neg­a­tives com­bined to send As­tral’s HEPS crash­ing 52% in its year to Septem­ber 2016 and a fur­ther 55% in its lat­est half year to March.

The lower maize price should take a good deal of pres­sure off As­tral’s prof­its in the six months to Septem­ber and es­pe­cially in its next fi­nan­cial year. Though some an­a­lysts are talk­ing this up as a rea­son to buy As­tral, its re­cov­ery ap­pears at least fully dis­counted by its share price’s 75% rise since early 2016.

As­tral also re­mains stalked by risk in­her­ent in the poul­try in­dus­try’s im­port cri­sis, which is driv­ing thou­sands of job losses. A res­o­lu­tion of the cri­sis re­mains elu­sive.

The sugar in­dus­try, though strongly pro­tected against im­ports, has also had its fair share of drought-in­flicted mis­ery. Re­flect­ing this, HEPS of Ton­gaat Hulett, SA’s largest listed sugar pro­ducer, fell a third over its two years to March 2016. Over the two years sugar pro­duc­tion from op­er­a­tions in SA, Mozam­bique, Swazi­land and Zim­babwe fell 25% to 1.023 Mt.

Pro­duc­tion re­mained well un­der milling ca­pac­ity of 2.1Mt in the six months to Septem­ber 2016 at 1.056Mt. But op­er­at­ing profit roared back, ris­ing 73% to R825m, which is R19m more than in its full year to March. 2016.

A num­ber of fac­tors were at work, not least a 29% rise in the reg­u­lated SA sugar price in 2016. The first hike of 12.5% was in Fe­bru­ary and the sec­ond, of 15%, came in July.

With the drought bro­ken, Ton­gaat Hulett is look­ing to a

The fu­tures po­si­tions are now start­ing to un­wind and will see a profit re­cov­ery get un­der way

sub­stan­tial rise in pro­duc­tion to 1.16 Mt-1.32 Mt in the year to March 2018 and 1.48Mt-1.59 Mt the fol­low­ing year. Ris­ing pro­duc­tion will bring big economies-of-scale ben­e­fits.

The group comes with an­other at­trac­tion: 3,149 ha of sugar fields in the Dur­ban area, ear­marked for ur­ban de­vel­op­ment over the next five years. Ne­go­ti­a­tions are un­der way for the sale of 227 ha and holds the po­ten­tial of a R1.8bn profit, says group CEO Peter Staude.

A strong profit re­cov­ery ahead and the prospects of hefty prop­erty prof­its make Ton­gaat Hulett a share worth close con­sid­er­a­tion.

This is de­spite a loom­ing tax on sugar-sweet­ened bev­er­ages, which could dampen de­mand. It may mean ex­port­ing more sugar, Staude has said.

With the world sugar stockto-use ra­tio at its low­est level in 30 years, in­creas­ing ex­ports would pose no prob­lem.

De­spite the harsh profit-bat­ter­ing some food com­pa­nies have taken of late, there are oth­ers which lived up to the sec­tor’s safe-haven sta­tus.

Among them is Tiger Brands, SA’s largest food group, which ended its six months to March with rev­enue up 12%. How­ever, re­flect­ing the pres­sure of high in­put costs, mar­gins were com­pressed, lim­it­ing the rise in HEPS to 5%.

For­tu­nately, Tiger has rid it­self of Nige­ria’s sec­ond­largest flour-milling firm, Dan­gote Flour Mills (DCF), in which a 65.7% stake was ac­quired in Oc­to­ber 2012 for R1,5bn. The deal was struck un­der former Tiger CEO Peter Mat­lare.

DCF was a hugely costly blunder, cost­ing Tiger R2.7bn in op­er­at­ing losses and R2.55bn in

as­set im­pair­ment charges be­tween 2012 and 2015.

It brought Tiger’s HEPS growth to a vir­tual halt at a time when ri­vals such as Pi­o­neer and AVI were de­liv­er­ing ro­bust growth.

The de­ba­cle was fi­nally brought to an end in De­cem­ber 2015 when Tiger agreed to sell DCF back to Nige­rian bil­lion­aire Aliko Dan­gote’s group for a to­ken US$1.

Un­der the lead­er­ship of Lawrence Mac­Dougall, Tiger CEO since March 2016, the group has also ex­ited Ethiopia and is now in the process of ex­it­ing Kenya. It leaves Tiger’s in­volve­ment in Africa al­most en­tirely driven by ex­ports from SA, no doubt much to the re­lief of its share­hold­ers.

The mar­ket has big ex­pec­ta­tions of Mac­Dougall, who beat 35 ri­vals, both lo­cal and for­eign, in the race for the CEO’s post. He brought with him 39 years’ ex­pe­ri­ence in the in­ter­na­tional fast-mov­ing con­sumer goods mar­ket.

Mac­Dougall has made it clear that his strat­egy in­cludes upping for­merly ne­glected mar­ket­ing spend and driv­ing sales of higher-mar­gin gro­cery prod­ucts ag­gres­sively.

Tiger is well po­si­tioned to do this, with power brands in its 42-brand line up in­clud­ing All Gold, Pu­rity, Black Cat, Tiger Oats, Koo, Crosse & Black­well, Hall’s and Fatti’s & Moni’s.

It is hard to ig­nore Tiger in any long-term port­fo­lio. How­ever, trad­ing on a 19.5 p:e it is not a share to rush out and buy. Rather hold out for a cheaper en­try point.

The food sec­tor has also dished up some pos­i­tive growth sur­prises in re­cent years, not least from Rhodes Food Group.

Since its list­ing in Oc­to­ber 2014, Rhodes has proved hope­lessly wrong those an­a­lysts — and there were many — who ques­tioned how a small-cap food com­pany could be brought to mar­ket on an 18.5 p:e.

As it turned out, the now 106-year-old Rhodes was listed on a bar­gain rat­ing. In its first salvo, it lifted HEPS by 137% in its year to Septem­ber 2015, fol­low­ing this with a 50.8% rise the fol­low­ing year.

Driv­ing HEPS has been solid or­ganic growth, with ac­qui­si­tions pro­vid­ing the re­ally big

The mar­ket has big ex­pec­ta­tions of Mac­Dougall, who beat 35 ri­vals, both lo­cal and for­eign, in the race for the CEO’s post

booster. Rhodes, which weighs in with a mod­est R6bn mar­ket cap, is far smaller than Tiger (mar­ket cap R75bn) and Pi­o­neer (R37.5bn).

But this brings a dis­tinct ad­van­tage: ac­qui­si­tions and new prod­uct cat­e­gories that

would barely move the nee­dle for big play­ers can pro­vide a size­able boost to its bot­tom line.

Since list­ing, Rhodes, led by dy­namic CEO Bruce Hen­der­son, has closed four large and four smaller ac­qui­si­tions at a to­tal cost of more than R840m.

First on board and bring­ing di­ver­si­fi­ca­tion into fruit juice were Pac­mar, ac­quired for R165m, and Boland Pulp, ac­quired for R174m. Rhodes is now sec­ond only to Pi­o­neer in the fruit juice sec­tor.

Be­ing a prom­i­nent player in its sec­tors is a key Rhodes strat­egy. Through brands such as Rhodes, Hazeldene and Bull Brand it is the mar­ket leader in canned pineap­ple, tomato paste, jam in glass jars and corned beef and num­ber two in canned fruit, canned jams, canned veg­eta­bles and canned toma­toes.

Armed with an ex­tra R662.5m in­jected by a cap­i­tal­rais­ing ex­er­cise in Novem­ber 2016, Rhodes’s next big step fol­lowed in Fe­bru­ary 2017 when it closed a R212m deal to ac­quire pas­try prod­ucts pro­ducer Ma Baker. It fol­lowed this a month later with a R200m deal to ac­quire Pakco, which brought with it wellestab­lished brands in­clud­ing Gold Dish, Pakco, Trot­ters and Hinds.

The ac­qui­si­tions set Rhodes up to de­liver HEPS growth of at least 20% in its cur­rent and 2018 fi­nan­cial years, a pace which ap­pears to pro­vide am­ple sup­port to its cur­rent 19 p:e rat­ing.

An­other group which has earned its high-rat­ing stripes is AVI, which has de­liv­ered solid growth un­fail­ingly over the past decade dur­ing which HEPS have more than tre­bled. AVI, which refers to it­self as a diver­si­fied con­sumer brands com­pany, has pow­er­ful brands on its side.

In the gro­cery cat­e­gory they in­clude Bak­ers, Five Roses, Fresh­pak Rooi­bos, Ciro, Koffiehuis, Frisco and I&J. In the high-end fash­ion and cos­metic cat­e­gories, the source of 35% of group op­er­at­ing profit, they in­clude Spitz, Kurt Geiger, La­coste, Yard­ley and Len­théric.

AVI de­liv­ered an 11.6% rise in rev­enue in its six months to De­cem­ber but a lower, yet still solid, 7.6% rise in HEPS. One key fac­tor lim­it­ing the HEPS rise was mar­gin pres­sure caused by high raw ma­te­rial in­put costs, noted AVI.

Con­sen­sus an­a­lysts’ fore­casts in­di­cate that AVI will de­liver HEPS growth of around 10% in each of its years to June 2017 and 2018. It leaves AVI’s 20 p:e look­ing rather pricey.

But there will al­ways be those ready to pay for the qual­ity AVI and many other food com­pa­nies have to of­fer.

Pic­ture: iSTOCK

Pic­ture: iSTOCK

Pic­ture: BUSI­NESS DAY

Lawrence Mac­Dougall

Phil Roux … Pi­o­neer’s CEO says 2016, marked by a drought and price hikes, was a year of hell

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