Otis Spunkmeyer owner Aryzta pledged to continue to invest in selling branded snacks through North American stores

Otis Spunkmeyer owner Aryzta pledged to continue to invest in selling branded snacks through North American stores

Aryzta, the Switzerland-based bakery products supplier, this week reported a drop in annual profits, although it managed to eke out some growth on its top line. The company has faced challenges in North America in recent quarters and the numbers bore that out, with sales boosted by its businesses outside that region. just-food presents the key takeaways from Aryzta's results and looks at how the company's views its prospects for the new financial year.

Annual revenues up - but profits fall

Alain Oberhuber, an analyst covering Aryzta at Swiss brokers MainFirst, called the bakery giant's full-year results "a mixed bag" and it was a fair summary.

Aryzta managed to increase its revenues in the year to the end of July by 1.5% to EUR3.88bn, although Oberhuber said the 0.5% in underlying growth the company reported was below what he had forecast.

The group's operating profitability was lower year-on-year. It reported a 5.7% fall in EBITA to EUR484.9m, pointing to the impact of investing in its branded business and, notably, the need to renew three long-term contracts, which led to lower volumes and pressure on efficiency.

Comparing Aryzta's reported net earnings EUR67m (versus EUR524.8m a year ago) was almost by-the-by, with one-off factors swaying the result but the company booked a 5.6% fall in underlying net profit from continuing operations to EUR311.5m.

On the positive side, Aryzta's free cash flow jumped as the company lapped a year of significant investment, particularly in production. "This shows the highly attractive, cash generative nature of speciality bakery once the initial investment has been made," Aryzta CEO Owen Killian said.

Nevertheless, some industry watchers suggested Aryzta's underlying profits had been helped by a fall in expenses down the income statement. "Lower finance costs and tax charges compensated for weaker than expected top-line growth and contracting margins," Investec analyst Ian Hunter wrote in a note to clients.

North America weighs on top-line

It was North America, the largest of Aryzta's three divisions by revenue and EBITA, that dampened the company's results.

Aryzta's business in the region has been battling declining underlying revenues since the second quarter of the group's 2014 financial year. Underlying sales remained in negative territory right through 2016, with the company reporting sales by that metric down 3.1% over the year.

The business pointed to the need to renew major contracts. Killian said it was a coincidence the three deals had to be re-signed at the same time, with two of the contracts coming the days before the merger that formed Aryzta in 2008. He acknowledged Aryzta would continue to feel the impact of the renewals in its current financial year but insisted: "This issue of contract renewals, while significant in FYs '16 and '17, is not a useful barometer of what happens throughout Aryzta. With the majority of our over 100,000 customers, we're engaged in growth initiatives and overall this business excluding contracts renewals grew 3.4% - and 2.2% in North America."

Growth in Europe and Rest of World segments

Aryzta's two other divisions - its business in Europe and its operations in the rest of the world - generated higher underlying sales.

In Europe, Aryzta saw its underlying revenue grow 4%, while its rest-of-the-world business booked a 6.2% increase.

Aryzta CFO Patrick McEniff said its recent acquisitions in Europe, Fornetti in Hungary and La Rousse Foods in Ireland, "performed strongly", helping to offset factors including a fall in tourism in France and pressure on pricing in Switzerland. The two acquisitions are part of Aryzta's bid to focus on higher-margin businesses.

From the rest-of-the-world business, which accounts for 6% of Aryzta's revenues, McEniff interestingly called out "a very strong performance in Brazil in local-currency terms". Brazil's economy has been under pressure, so it was notable Aryzta emphasised how well it is seeing its business perform there.

Aryzta's forecasts for 2017 financial year

In the current year, which started on 1 August, Aryzta expects to grow revenues by 1-2% on an underlying basis, a slight acceleration in the organic growth it saw in the last 12 months.

The company also forecast its EBITA margin would stand between 11.5% and 12.5%. If Aryzta hits the top end of that range, it would match the 12.5% it generated in the year has just gone, 12 months in which the margin metric fell from 13.5% in the previous year.

Reflecting on Aryzta's sales forecast, Killian said the company expects its underlying sales - after stripping out the impact of the contract renewals - to grow 2-4%.

Aryzta expects the impact of the contract renewals on margins to continue to be felt in the new financial year but said that could start to be offset by production at a new facility in Germany, which the company expects to help it launch more products.

Killian said the lower guidance was "prudent" as the renewal of the contracts meant Aryzta was having to use its capacity in different ways. "By definition, a lot of these long-term contracts have lower price-points but, because they have limited items on the same production line over very long time periods and when you're constantly improving the processes, the margins improve over time. Even at relatively low price points, they generate very attractive margins," he said. "On the other hand, innovation and NPD [are] the real driver of revenue growth and also the driver of improved price points. However, while these new items are in start-up and build-up phase, they are somewhat margin destructive because you're testing on lines, you're testing with customers and you're testing a lot of food items instead of a very narrow range. When you're transitioning from what is a very stable, small number of food items on lines that are very repetitive processes into new items, we think it's prudent to guide some margin decrease during that phase."

At MainFirst, Oberhuber described the guidance as "a more realistic outlook than in the past".

Aryzta and North America

After another year of falling underlying revenues in North America - even if Aryzta could point to a deceleration in the rate in which sales declined quarter by quarter - analysts on the conference call with Killian and McEniff were keen to find out how the company saw its prospects in its largest market in the new year.

Societe Generale's Warren Ackerman asked for Aryzta's thoughts on the quick-service restaurant channel in North America, which accounts for 30% of the company's sales in the region but which is one of the most intensely competitive parts of the foodservice sector, particularly in the US. 

Killian said the proportion of Aryzta's sales in North America made through the QSR channel was falling year-on-year - due to the contract changes, it dropped from 34% a year earlier - but he emphasised the importance of that part of the market to the company.

"The QSR channel in North America is a very dynamic channel. It is the location of choice for most American consumers but it's a highly competitive landscape with market shares switching around on promotions between the various players. It's still a very important channel. A large part of our strategy in North America is to play across the segment with the various players in that marketplace so we can take advantage of consumer swings," Killian said. "There's a consumer change taking place in terms of their value proposition, value expectations, personalisation and experience. It's going to be a very dynamic sector over the course of the next number of years. We don't see it being like it was five or ten years ago."

Another factor to consider when looking at Aryzta's forecast for group EBITA margin for the new financial year is its plan to continue to invest in its branded business, particularly in North America, which the company sees as a way to drive its sales.

During the year, Aryzta decided to give a fresh push to its US foodservice bakery brand Otis Spunkmeyer in the country's retail channel. Aryzta had already been selling some Otis Spunkmeyer products to convenience stores and small grocery chains but moved to take the brand into national retailers.

"We have gems within our business that we have not been investing in in the last number of years, particularly La Brea Bakery and Otis Spunkmeyer and you're going to see more colour on that on our Capital Markets Day [on 5 October] when the teams in North America paint a picture of where they are trying to get to," Killian said. "As a result of our investment in [North American bakery] Clover Hill, we have the capability to do branded snack cakes and to compete in that sector. Snacking is a very important component of the lifestyle in North America and that's largely where our investment in brand is taking place."

With the plethora of snacking products in US retail stores and the might of retail-focused companies like Grupo Bimbo and Flowers Foods entrenched in the market, it will be a challenge for Aryzta to build and establish a retail, branded snacks portfolio, even with the recognition among consumers of brands like Otis Spunkmeyer and the company's relationship with retailers through its supplies to in-store bakeries.

Watching brief on Picard

Aryzta's results included contributions from two ventures in which it is a shareholder, including last year's surprising investment in Picard, the France-based frozen food retailer.

The company acquired 49% of Picard from private-equity firm Lion Capital last year, a transaction that stunned some analysts and garnered a mixed response from shareholders, with some in the investment community questioning the move. Aryzta has an option to buy the rest of Picard in a period from the company's 2019 financial year to its 2021 fiscal period.

On Monday, as Aryzta discussed its annual results with analysts and brokers covering the business, one analyst asked the company's management if it still believed buying 100% of Picard was "strategically an important milestone in the medium to long term" for its business.

Killian replied: "That is correct." However, he added: "There is no obligation on Aryzta to exercise the option to acquire Picard. What we have negotiated with Picard is a call option. We have a right to acquire Picard but we've got to go through certain stage gates in order to be able to do that."

Investec's Hunter believes there has been "a subtle shift" in Aryzta's position on Picard. The impression to-date was that all efforts were focused on establishing a solid financial footing to take up the option over the 50.5% of Picard not already held. Now, however, management is referring to "stage gates" that have to be met including Aryzta generating EUR1bn in cash by 2020, both Picard and Aryzta's performance in the interim period and the investment case at the time of considering the options. This, in conjunction with a new chairman, could help assuage investors' concerns on strategic direction."

At MainFirst, Oberhuber added: "Because of Aryzta's current performance, the deal is more likely to be done, if at all, in FY21."