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October 4, 2018

Has Aryzta found right mix to grease recovery wheels?

Despite another year of losses, Aryzta says it can return to growth after selling assets - with potentially more to come. But success hinges on a vote on a capital-raising plan.

Despite another year of losses, Aryzta chief Kevin Toland is adamant he can return the business to growth after offloading a number of assets – with potentially more to come. But success hinges on a shareholder vote on a capital-raising exercise. Simon Harvey assesses the outlook.

Investors have shunned Aryzta this year, with the Swiss-Irish bakery group’s share price losing more than two-thirds of its value amid a series of earnings warnings, which culminated this week in the company reporting another year of losses.   However, markets reacted positively to the latest set of financial results on Monday (1 October) after Aryzta CEO Kevin Toland painted an outlook for growth for the year ahead having achieved some success in trimming a bloated debt pile and disposing of a batch of non-core assets.

Toland and CFO Frederic Pflanz are among a slew of executives brought in over the past 12 months or so to turn around the Zurich-based business, which has found the going tough in recent quarters. Aryzta has particularly been blighted by its under-performing North American operations, and of late, rising commodity prices in Europe and labour costs in the US.  

While Toland has launched a three-year, EUR200m (US$230m) cost-savings programme – Project Renew – to revitalise the financially-embattled firm, he has come under pressure from at least two investors to abandon a pipe-lined capital-raising exercise to support his rejuvenation plan and cut billions of euros in debt. 

Instead, stakeholders say he should divest more assets, including a 49% holding in French frozen-food company Picard, a disposal that has long been pushed for by analysts, and a business which Toland this week said he was “committed” to getting rid of.

Back-to-basics recipe

Shares in Aryzta, which supplies buns to fast-food bellwether McDonald’s, as well as major retailers, rallied by more than 30% on Monday following the release of the company’s financial results for the year to 31 July, despite Toland’s description of the period being “not a good year”.

But MainFirst analyst Alain Oberhuber said the rally could only be put down to stock investors covering a “high level” of short positions – meaning market participants were covering wrong-way bets  the share price would fall.

Nevertheless, seen in the context of the moment, the CEO predicted “mid-to-high single-digit 2019 growth” in underlying organic profit, or EBITDA, which would represent a vast turnaround from the 28% slump just reported for the year to EUR302m. And more importantly, such an outlook suggests Toland is confident his “back-to-basics strategy” will reap the desired outcome of returning value to shareholders.

Toland: “This is a growing market with compelling long-term potential which we are confident we will participate and win in”

“This is a growing market with compelling long-term potential which we are confident we can, and will participate and win in,” Toland said on an analyst call on Monday. “That confidence is built on a clear turnaround strategy, which will take time to implement but will position us for improved performance and growth. 

“We have established clear strategic priorities and now have a strong team in place to deliver on those priorities. It is built around Project Renew – focused on customers, the market, operations, and rigorous financial controls.”

Business disposals and Picard

Aryzta’s debt ballooned under the watch of former CEO Owen Killian as he embarked on a plethora of acquisitions, including Cloverhill bakery, Picard and Signature Flatbreads. A year after the company was formed in 2008 through the merger of IAWS Group plc – then headed by Killian – and Hiestand Holding AG, debt stood at EUR505m.

By the end of fiscal 2017, the pile had more than tripled to EUR1.73bn through a combination of bank loans and revolving credit facilities. And in 2019, Aryzta has EUR326m of debt coming due.

Toland spoke of a “legacy” of issues that had dogged Aryzta, including an unfocused strategy; a “disparate group of businesses”; a lack of shareholder engagement; and a “progressive loss in talent”.

“We over-expanded,” CFO Pflanz added.

However, debt fell to EUR1.5bn as of July to represent a ratio to EBITDA of 3.8 times, which includes the impact of a Picard dividend payment. That said, Pflanz admitted Aryzta still remains “highly leveraged” and he hopes to realise a net-debt-to-EBITDA target of 2.6 times following the EUR800m rights issue. 

The company previously stated it planned to raise around EUR450m through the disposal of non-core assets as part of a EUR1bn deleveraging exercise, and during 2018 and the back-end of 2017 offloaded its Cloverhill bakery business, Signature Flatbreads and foodservice supplier La Rousse Foods of Ireland, reaping a total of EUR137m. And Aryzta also received EUR91m in dividends from Picard for the year.

While Toland acknowledged the funds fell short of his goals, he said management had identified other disposals within the group and will announce details once negotiations have been completed.

One would assume the plans exclude the 49% stake in Picard, which the company acquired in 2015 for EUR451m, a deal ex-CEO Killian described as being “consistent with Aryzta’s strategy of consumer relevancy through diversifying markets and channel positioning”.  

However, the sale of Picard remains a challenge as Aryzta can only offload its stake in agreement with Lion Capital, the UK-based, private-equity firm that owns the other portion, although both parties have been exploring options.  

“Aryzta has to find a partner, and find mutual agreement with the main shareholder,” MainFirst’s Oberhuber said this week. “This is a process which will require more time than had previously been expected.” 

Toland said he is “absolutely committed” to the disposal of Picard because the business resides outside of Aryzta’s core focus, but first a potential buyer needs to be found “at the right price”.

“Aryzta is not a good owner of this business”, he added, even as Picard booked annual sales of EUR1.45bn and EBITDA of EUR207m.

Activists turn up the heat

Pressure mounted last month when investor Gregor Joos – who is seeking to gain an initial 3% stake in Aryzta and then 10% – urged Toland to accelerate Picard’s sell-off, and at the same time offload its ailing North American business, which includes La Brea Bakery and Otis Spunkmeyer in the US. 

But Toland has been steadfast in opposing a sale of La Brea. In March, he said it was “fundamental to our business and offerings in North America, so that’s [not being] and won’t be contemplated at any point”. 

Joos has urged Aryzta to focus its attention on Europe, and at the same abandon the planned capital raising.

It was the same opinion voiced by another investor this week – Cobas Asset Management, which owns more than 14% of Aryzta. While the asset manager said it endorsed strengthening the balance sheet, it said it is “reviewing alternatives that will improve upon the company’s proposal”.

No doubt that will amount to a vote on the plan by Cobas at a shareholder meeting slated for 1 November, which could derail the rights issue. It is expected to close on 19 November. 

But Toland said the extra capital will reduce the immediate pressure to dispose of Picard.

The CEO said: “While the business [Aryzta] has clearly been challenged we have a core underlying business which is cash generative and profitable. Fundamentally, the biggest issue facing us today is that our balance sheet is one that cannot be sustained as it is. Our capital raise will help sustainably strengthen our balance sheet and provide us with the time and space to capitalise on the true potential within our business.”

Funds from the capital increase are to be put to work to strengthen Aryzta’s capital base, reduce leverage and financial risk, and provide EUR150m in funding for Project Renew.

If the cash plan is approved, another EUR500m will be channelled into paying down debt and the rest will go toward paying fees to advisers and for liquidity.

“It looks like that the worst could be over,” said MainFirst’s Oberhuber. “The company gave guidance for FY-19 in the medium term, a detailed answer about the cost-savings programme, [and] the usage of the proceeds of the rights issue and the timetable.” 

The capital raising is “crucial for the good financial health of the company”, Toland said, adding it would “provide funding for other selective investment projects in growth markets”, although he did not elaborate.

CFO takes dig at Brexit

Project Renew targets an annual run-rate in savings of EUR90m by fiscal 2021 and beyond. Meanwhile, EUR120m will be ploughed into capital expenditure for the new financial year, with an additional EUR45m expected to support Project Renew. 

Aryzta will also invest 3.5% to 4.5% of its revenue in manufacturing in the “medium term”, excluding inputs to Project Renew.

“A successful capital raise will provide us with an effective capital structure which will allow the management team to fully focus on driving the success of the business,” Toland said. “Within our existing asset base, we have well-invested assets with capacity to grow, particularly when we complete Project Renew. However, while our asset base is relatively well-invested, we have to make a significant investment in automation through Project Renew to make the business as efficient as it can be.”

While Aryzta’s North American business has struggled of late, CFO Pflanz said the market had stabilised in the US and Canada, and there were signs the environment is improving. The region as a whole “got gradually better” after the disposal of Cloverhill, he added.

In Europe, Aryzta faced margin pressure due to increased butter inputs, which it “tried to recuperate in pricing, but did not fully manage to do so”, the CFO said.

And in what can only be construed as a dig at Brexit, Pflanz said Aryzta experienced foreign-exchange pressure on cross-border sourcing linked to sterling, which “is a nice way of saying difficulty related to England”.

Net revenue fell 10% to EUR3.4bn, a sharper decrease than the 2.1% seen in 2017, when EBITDA slumped 31% to EUR420m. 

Of the revenue decline in 2018, 46% was linked to foreign exchange and 40% to disposals. Organic revenue dropped 1.2% but would have been up 0.5% if Cloverhill was discounted.

Meanwhile, underlying net profit also took a hit, coming in at EUR49.6m, compared to EUR179m the prior year, resulting in a diluted EPS rate of 55.4 euro cents versus 201.6.

However, on an IFRS basis, the company booked a EUR470m loss, narrowing from EUR906m.

But with Toland anticipating a return to profitability in underlying EBITDA to the “mid-to-high single-digit” range, and an improvement in the associated margin to 12-14% in the medium term – it dipped to 8.8% in 2018 from 11.1% – the outlook does appear more rosy.

Still, the proof will be in the pudding, with the margin guidance already above MainFirst’s outlook of 11.4% for 2020 and 13.7% for 2021. “We would wait until the rights issue is done,” said Oberhuber. However, in a sign of confidence over Toland’s margin objectives, MainFirst raised its estimates on Thursday (4 October) to 11.7% and 14%, respectively.

And to solidify efficiency and monitoring, 2019 will involve a focus on financial management by each geographical region and monthly performance reviews to gauge progress.

“We are realistic about the challenges we are facing and what has to be done to address them,” Toland said. “But we are confident that our capital raise and the successful execution of Project Renew, in combination with a deep focus on our customers’ operational efficiency, will over time rebuild value for shareholders.”

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