Financial Mail - Investors Monthly
PRICEY, SPICY... OR PALATABLE?
Order carefully from the JSE's food sector to avoid indigestion
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.