North America remains concern for Aryzta watchers

North America remains concern for Aryzta watchers

A third of the way through a transformation exercise, Swiss-Irish baker Aryzta has made some progress, particularly in offloading non-core assets and cutting debt. But, despite a return to profit, as seen in the latest annual results, legacy issues remain. Simon Harvey looks at the key takeaways.

Aryzta this week revealed a mixed bag of annual results a year into a three-year transformation programme to stabilise what had been a loss-making business of late, but legacy challenges still need to be addressed to get the Swiss-Irish bakery business back on a path to sustainable growth.

The company marked a return to profit in the year ended July and expanded margins, but the progress made across those metrics fell short of chief executive Kevin Toland's expectations. And while revenues were down and organic growth was flat, Aryzta continued to eat into a debt pile bloated by acquisitions instigated under his predecessor, albeit with the help of a recent and sizeable capital-raising exercise. And debt leverage is coming down too.

Most notable, and a detail unveiled last Tuesday (1 October), was the long-awaited sale of Aryzta's stake in French frozen food retailer Picard, part of a streamlining process to get rid of what Toland considers non-core assets, and which has also included the completed disposals of Cloverhill, Signature Flatbreads and La Rousse Foods. And this week, the CEO noted it had just secured a deal to offload its UK Food Solutions business, although revenues for that operation are relatively small.

However, North America remains a challenge and a region some analysts have suggested Aryzta should exit to focus on its mainstay European business, although Toland has insisted that prospect is unlikely. And it's not surprising given North America accounts for 40% of group revenues and 32% of profits measured by EBITDA.

Alain Oberhuber, a consumer goods analyst at MainFirst Schweiz, had this to say after hosting a roadshow with Toland and finance chief Frederic Pflanz: "We conclude that fiscal year '19 was a year of stabilisation with a better leverage and ongoing operational improvements. Nevertheless, many things still have to be done and the business is still in a troubled situation. In particular, the North American market has low visibility for fiscal year '20."

Soon after Toland joined Aryzta in 2017, he introduced a three-year EUR200m (US$219.6m today) cost-saving strategy dubbed Project Renew. He proceeded to cut the headcount, improve efficiencies and optimise the supply chain.

But when Aryzta announced its annual results on Tuesday (8 October), markets were unconvinced over the progress made so far, sending the stock down 9% at one point in afternoon European trading. It was weak again today at CHF0.69 ($0.69) a share, compared to CHF1.21 at the start of the year and CHF2.31 this time in 2018.

Muted performance in North America

North America has been a drag on Aryzta's performance for some time and it was no different during the last 12 months, with the increase in private label in the US cited by Toland as one of the hurdles in a "competitive retail environment".

And it won't be until the third quarter of the current financial year – started 1 August – that Aryzta expects to see a pick-up in the region as the "impact of volume" declines seen in 2018 continues into the next two quarters.

Organic revenues in North America fell 3.8%, or $66m, while Europe posted a 1.9% increase and the rest of the world surged 8.9%.

Those same revenues are expected to "remain challenging" in 2020 but with "positive evolution" in the second half, Toland says, but he's still committed to retaining the operations.

"It's a very important element of Aryzta's business," the CEO told analysts on a post-earnings call. "We are very focused on the issues and are making progress" but there are still "revenue stabilising issues to address", he adds.

The under-performance was put down to problems with key customers in the retail and quick-service restaurant (QSR) divisions, .

Organic revenues in "large retail", which account for 28% of the North American business, dropped 7.4%, with 70% of the loss attributable to one unnamed customer. To address the decline, Toland said new products are in the pipeline and are due for launch this year.

QSR, representing a larger 45% slice of the regional business, saw organic revenues dip 1.9%, or $14m. Despite the decline being related to a $15m loss from one customer, Aryzta said it signed a new "multi-year contract" with the same client, and again is planning to roll out "innovative new category solutions", Toland said. 

"Customer relationships have been repaired and strengthened," Toland said. "Innovation will be focused on core higher-margin categories at the expense of non-core, lower-margin categories."

He added: "North America continues to not only be an important region for the group but also for the overall global bakery market, and we are absolutely committed to continuing EBITDA growth and stabilising revenue."

Retained Picard stake unexplained

Aryzta finally found a buyer for Picard in the shape of Tunisia-based Invest Group Zouari. It acquired 49% of the business in 2015 for EUR451m, but only sold 43% for reasons unexplained by Toland, getting EUR156m from the deal.

All he did say was: "It's the best and right deal for the company including retaining that remaining stake." Announcing the deal, Aryzta said the remaining Picard holding would be "monetised at a later stage".  

Finance chief Pflanz said Tuesday he expects a one-off accounting loss from Picard of around EUR280m.

Still, non-core asset disposals, including Picard, Cloverhill, Signature Flatbreads and La Rousse, equate to EUR380m, Aryzta said last week, short of the targeted EUR450m under Project Renew. 

Toland said that, once the Picard sale is complete, the company would realise 85% of the net proceeds from the unwanted non-core operations. But then he also revealed Aryzta had just completed the sale of the UK Food Solutions business for EUR8m.

So that leaves markets wondering what else could be on the chopping block outside of the core businesses of artisan bread, buns, donuts, cookies and laminated doughs, or if the balance will be generated from other physical assets such as bakeries and plants. Toland said he has sold two loss-making bakeries in Europe and closed a bakery in North America for the first time.

Debt still too large

Aryzta's debt had ballooned under former CEO Owen Killian owing to a slate of acquisitions. A year after the company was formed in 2008 through the merger of IAWS Group plc – then headed by Killian – and Hiestand Holding, debt stood at EUR505m.

As 2017 drew to a close under the watch of newly-installed Toland, debt more than tripled to EUR1.73bn. Fast-forward to July this year, and the load had more than halved to EUR733m – the lowest since 2013 - from 12 months earlier and was down from EUR811m at the end of January.

Before the company embarked on a capital raising exercise last year, CFO Pflanz indicated he was seeking to get financial leverage down to about 2.6 times once the deal had been done. And after securing EUR790m through the issue of new regulatory shares, Aryzta had notched up a better-than-targeted 2.43 times, as measured by net debt to EBITDA, by this fiscal year-end.

But the figures exclude what is termed hybrid debt, or perpetual, callable, subordinated notes, denominated in euros and Swiss francs, which when taken into consideration push the debt up to EUR1.6bn.

And run-rate savings under Project Renew have played their part too. Aryzta said it realised EUR26m in benefits in fiscal 2019 to give an annual run-rate of EUR40m, which is expected to rise to EUR70m this year and EUR90m in 2021.

EBITDA disappoints 

Toland refrained from giving any concrete guidance for the new fiscal year, which was seen as a negative by Oberhuber for the "lack of visibility".

All Aryzta would reveal is the company expects "to see underlying EBITDA growth for FY-20 as the benefits of the second year of Project Renew are being realised", and for North America, "an improved underlying EBITDA performance".

He may be wise to be cautious given both underlying EBITDA growth and the associated margin improvement failed to meet his expectations laid out last year, of mid-to-high single-digit growth in the former and 12-14% for the latter.

EBITDA growth registered 1.9% to EUR308m, while the margin climbed 30 basis points to 9.1%, which Toland admitted was "way off our medium-term target". And revenue failed to improve too, dropping 1.5% to EUR3.38bn, although net profit surged 50% to EUR74m.

Oberhuber notes: "Despite these cost savings [Project Renew], we see the necessity for Aryzta to improve its organic sales growth to achieve its mid-term EBITDA guidance. However, for North America, Aryzta does not plan to achieve organic growth for fiscal year '20. With its low utilisation, the US has meaningful potential for margin improvements." 

In the meantime, markets envisage a 9% increase in EBITDA for the new year, to which Toland was asked to give his thoughts.

"It's very early in the year and we have been clear on what's happening, and we've been very clear on what we see is driving our growth going forward," he responds. "We are not actually calling out a number and I think as the year evolves we will be providing more granularity."

"Prepared as we can be for Brexit"

Brexit was given notable prominence in the slide presentation to accompany the earnings call, a matter of weeks before the UK is due to leave the European Union. But Toland said Aryzta should see a limited impact given the level of its business in the UK is small, even though market watchers suggest there could be implications for Europe, too, whatever the outcome.

"We are prepared as we can be for Brexit given the high levels of ongoing uncertainty," he said. "We've been fully engaged with our customers around greater plans and have taken steps to deal with short-term operational planning. 

"Long-term risks remain given the lack of clarity. However, the FY-20 impact is not expected to be material and the total revenue exposed to the UK is less than 5% of group revenue."

Aryzta said it has made certain contingency plans such as having allocated warehouse space to accommodate frozen products should it have to increase inventory levels, and has also engaged in currency hedging to mitigate any impact from fluctuations in exchange rates.

All in all, Toland has made some inroads into achieving his objectives even if he is only a third of the way through Project Renew. And with any improvement in the North American market not really expected until at least the third quarter, meaning February or beyond, investors may not be so forgiving it he doesn't deliver. 

Either way, they will be looking for more concrete evidence that a turnaround is well entrenched to warrant a return to the share price of years gone by, and to halt the downward spiral of the last five years.

But Toland remains confident, as he outlined in his earnings commentary: "The steps we have taken in FY-19 have established foundations on our path towards stability, performance and growth. We are realistic about, and resolved to address, the clear revenue challenges presented by our North American business."