Premier hopes JV investment will drive Hovis gains

Premier hopes JV investment will drive Hovis gains

Premier Foods plc announced earlier this week that it will establish its bread business as a standalone joint venture, in which US private equity firm Gores Group will hold a majority stake. The company clearly hopes that - in conjunction with its new partner - it will be able to rejuvenate its the struggling bakery unit. Nevertheless, a number of challenges lie ahead for the heavily indebted UK food major. Katy Askew reports.

Premier Foods moved to quell months of speculation when it confirmed plans to separate its struggling bread unit and form a joint venture with US investment vehicle Gores Group. The deal will see Gores take a 51% stake in the newly established company, Hovis Ltd.

According to the terms of the transaction, Gores will pay GBP30m (US$49.7m) for the bread business, of which GBP15m is deferred and dependent on the future financial performance of the business. Including working capital, Hovis Ltd has an enterprise value of GBP87.5m.

In the year to end-December the Hovis business recorded sales of GBP654.6m, EBITDA of GBP21.9m and trading profit of GBP6.3m. The new venture comprises the Hovis brand as well as Mothers Pride, Ormo, Granary & Nimble and all of the of the company's operational bakery and milling estate.  

Net cash proceeds from the agreement total GBP28.7m, Premier revealed.

For Premier, it would seem this agreement is less about the cash in-flow as it is about securing funds to revitalise the Hovis brand. As Investec analyst Nicola Mallard notes: "This deal is not about cash in. It is more an intention to reinvigorate Hovis - the plan is to invest GBP200m over the next five years. Premier will benefit from any upside in the brand that comes from this, via its 49% stake."

Indeed, commenting on the deal, Premier CEO Gavin Darby emphasised that the firm stands to benefit from a turnaround of the struggling bread unit. "We will share in the future gains from this investment as the business continues its return to profitable growth, helping us maximise value creation," he stressed.

The five year plan for Hovis will target improved efficiency and cost reduction while simultaneously extending the brand's appeal through innovation and NPD. Premier and Gores have already committed GBP45m of cash funding, of which GBP32m will invested in year one of the venture. Future bread profits and third party financing will be used to hit the GBP200m investment target, Premier revealed.

The company hopes this will be enough to address some of the significant issues that have weighed on the performance of its bread business in the highly price-sensitive and promotional UK bread category.

While the deal might facilitate the turnaround of Hovis on the one hand, on the other it could potentially allow Premier room to develop the potential of its stable of well-known, higher margin grocery brands.

As Shore Capital analyst Clive Black notes, the Hovis disposal will allow Premier management to focus its energy on improving the performance of its remaining brands, including Mr Kipling cakes and Oxo gravy. The deal "permits Premier Foods' management to focus upon what is a decent stable of largely ambient grocery brands with robust margin credentials in the UK," Black observes.

Premier already has plans for the near-GBP30m in cash that will be generated by the deal. The group said that it will plough the proceeds back into its core grocery business. Specifically, Premier said that it intends to improve capacity in its cake unit, including the investment of approximately GBP20m in a new snack pack cake slice line at the company's manufacturing site in Carlton, Barnsley.

While the cash injection that this transaction has provided - to both the cake and bread businesses - bode well for Premier's top line in the long term, the company must still grapple with the epochal challenge of its high level of leverage.

The financial troubles at Premier have been well documented. Premier is struggling under a massive debt burden: net debt totals around GBP890m and the group has a pension deficit of GBP394.7m.

The company has made strides in addressing its balance sheet issues in recent years. It has divested a number of non-core businesses, secured new financing agreements and stripped complexity (and costs) out of its remaining units.

Darby is driving a bid to make Premier a leaner machine - and one that will see profits return to a strong growth trajectory. The group has also made moves to consolidate its supply base, rationalise SKUs and strip complexity out of its manufacturing network.

Updating the market this week, the group revealed that it is in "constructive discussions" with its pension trustees in relation to the 2013 actuarial valuation of the pension schemes and associated recovery plan. Premier added that it is reviewing a "full range" of options regarding its future capital structure.

The disposal of a majority stake in Hovis Ltd will result in an immediate top-line hit of approximately 12%, increasing the company's net debt to EBITDA gearing ratio to over five times in the coming fiscal. While the transaction frees up some cash to invest in the business, it also places the grocery business under more pressure to generate cash, Panmure Gordon analyst Damian McNeela suggests.

"We understand that the company is making progress with the pension trustees but note that this transaction places further pressure on the cash generation of its grocery business, as any cash generation from the bread business is unlikely to ever make it back to Premier. Accordingly if Premier wish to ‘normalise' its capital structure a combination of debt refinancing and a rights issue are likely to be required," he predicts.

Analysts have repeatedly suggested that the firm could look to raise GBP300-400m through a potential rights issue. Given Premier's current capital structure, the market consensus seems to suggest that it is not a question of 'if' but 'when' Premier moves to offer a rights issue.

All eyes have now turned to mid-March when Premier will deliver its full-year results. Will this also include long-awaited details on how Premier intends to right its balance sheet?