Spreads to fatten margins?

Inserting Unilever’s margarine brands into RCL’S could add some fatty flavour to margins

Will investment giant Remgro spread out the brands portfolio at RCL Foods to make its underperforming foods subsidiary a more nourishing prospect for investors?

As it stands, Remgro owns 77% of RCL, which owns brands such as Selati sugar, Rainbow chicken, Supreme Flour, Sunbake bread, Yum Yum peanut butter and Ouma rusks.

But RCL’S stock has floundered, rising just 25.6% over five years — far behind rivals AVI (up 64.7% over that time), Pioneer Foods (up 108%) and Tiger Brands (37.5%).

Optimists claim RCL is long overdue a period of outperformance. And yet, questions linger about whether the company is really lean and mean enough to compete with larger rivals.

A quick scan of the most recent RCL annual report shows some startling statistics: RCL’S employee costs stand at almost 17% of revenue, with operating profit generated per employee coming in at less than R40,000.

This stands in stark contrast to Tiger Brands, which has a staff-cost ratio of 10.5% of revenue and operating profit per employee of more than R290,000. Pioneer Foods shows staff costs at 11% of revenue with operating profit generated per employee of about R270,000.

One encouraging development is that the remuneration costs for top executives — CEO Miles Dally and FD Rob Field — have fallen from R24.5m last year to about R18m this year. But the market might still question paying executive bonuses of R4.6m when returns to shareholders have been so lean over the past five years.

Quite how these executives plan to create value in a dour consumer environment is anyone’s guess. But what does seem certain is that two issues — that could materially change returns — will probably play out from next year.

The first is the effect of the culling of the commodity arm of Rainbow’s poultry business to rather focus on value-added offerings and servicing the fast-food sector.

The second is the opportunity for Remgro to push the spreads businesses it wants to buy from consumer brands giant Unilever into RCL.

The Rainbow chicken business has not exactly feathered RCL’S profit nest of late. Some analysts argue RCL should have unbundled Rainbow, following similar efforts to toss out the poultry arms by Tiger Brands and Pioneer.

But recent plucky trading updates from JSE “big bird” Astral Foods, as well as smaller poultry players such as Sovereign Foods, suggest profits may fly again at a reshaped Rainbow.

There were already signs of a better performance from Rainbow in the second half of the past financial year, as the shift from commodity-type production to higher-margin quick-service restaurants led to the number of birds produced every week dropping from 4.7m to 3.8m.

The outbreak of avian flu is a risk — but it seems certain that production cost savings should fatten margins markedly next year.

Rainbow has also shown encouraging gains in the freezer-to-fryer poultry segment, in

RCL Foods

which its market share jumped from 24% in June 2016 to nearly 40% in the past year.

The second issue is more fluid, as the proposed deal between Remgro and Unilever has not been finalised. This deal would entail Remgro selling its 25.75% stake in Unilever SA back to the multinational brand giant in exchange for R4.9bn in cash and full ownership of Unilever’s spreads (mainly margarine brands such as Flora, Rama, Ola and Stork) in Southern Africa.

Remgro CEO Jannie Durand warns against making assumptions around plans for the spreads business. That’s fair enough — but it would be surprising for Remgro not to usher the Unilever spreads business into RCL. It’s worth recalling that in 2013 Remgro stirred its sugar business, TSB (Selati), into RCL.

The terms of the Unilever deal infer a value of R7bn for the spreads brands. This would be a huge deal for RCL to swallow, as it only has a market capitalisation of about R14.7bn.

But the spreads business would add a dominant market niche (as well as much-needed bulk) to RCL. It’s worth noting that while RCL holds strong positions with Yum Yum (31% market share), Nola (43%) and Ouma (47%), there are currently only a handful of brands — Selati, Rainbow, Supreme, Sunbake and Epol pet food — that generate sales of more than R1bn/year.

The estimated profit attributable to the spreads brands was R338m compared with RCL’S bottom line of R600m for the year to June.

Assuming the Unilever deal is finalised before April, the big question will be how the spreads business could be reversed into RCL.

Two options seem likely.

First, RCL could pitch a rights issue to shareholders to introduce new shareholders (underwritten by Remgro) to raise funds to buy the spreads brands. But there might be some reluctance to do this, with the RCL price so low.

Second, Remgro could inject the spreads assets into RCL in exchange for new shares, perhaps tagged to a clawback offer to accommodate minority shareholders.

The lack of appetite for RCL’S shares might well give Remgro, which has openly stated its preference for unlisted investments, an opportunity to markedly increase its controlling stake — even to a level at which it makes sense to make another offer to buy out minority shareholders and delist it.