Cost control helped margins amid meagre sales growth

Cost control helped margins amid meagre sales growth

Orkla, a bellwether for trading in the FMCG markets of the Nordics, has booked its first-half results. Dean Best provides the top takeaways from the company's performance and its commentary on the months ahead.

Nordic FMCG heavyweight Orkla, home to brands from Grandiosa pizza and Felix ketchup to Sun dishwasher tablets and Blenda washing powder, had a mixed first half.

Consumers' pantry-loading of late-March boosted Orkla's first-quarter sales, with turnover from the company's core branded consumer goods operations up more than 5% on an organic basis, a rate of growth far stronger than its recent record.

Growth in the second quarter was harder to come by. Underlying sales from Orkla's branded consumer goods fell nearly 4%, hit by consumers, with their loaded pantries, de-stocking and by the near-shutdown of the out-of-home market.

In 2019, around a quarter of the sales from Orkla's branded consumer goods business came from its food ingredients unit, which supplies the bakery and ice-cream markets. Artisanal and industrial bakeries account for half the sales from food ingredients, which suffered as Covid-19 hit out-of-home consumption.

While Orkla's sales were up-and-down in the first half, the company's profit performance was more robust, with cost savings helping to boost underlying EBIT and margins, cheering analysts. Improvement in Orkla's margins was seen as a key priority for chief executive Jaan Ivar Semlitsch when he joined the business last year.

"Overall," Semlitsch said yesterday (13 July). "I'm satisfied with our performance during the first half year, during these extraordinary times."

Covid-19 leads to uneven sales

Orkla's first six months was a half of two halves. After a first quarter of 5% underlying sales growth, the April-to-June quarter saw a decline of 3.8%, leading to a mere 0.7% rise over the opening six months of 2020.

Two factors were at play, Orkla said. A reversal in the consumer stockpiling of the first quarter and a fall in out-of-home consumption in the second.

During the first half, Orkla saw organic sales from its foods division grow 5% and, by the same metric, sales from its confectionery and snacks arm rise 3.1%.

It was Orkla's food ingredients arm that felt the impact of the slump in the out-of-home market, with sales from that business down more than 9%. "During Q2, most of our markets have experienced lockdown and restrictions put in place by governments to limit the spread of the virus. This has had significant negative effects on the out-of-home channel," Semlitsch said. "Growth in in-home consumption and grocery retail has not been enough to offset the negative growth impact out-of-home exposed business."

Martin Stenshall, an equity research analyst covering Orkla for Danske Bank Markets, noted how the 0.7% rise in sales compared with the company's recent quarterly growth and added: "It's a low number. I had actually expected a bit higher organic growth as people in those regions, mostly the Nordics, had then stayed domestically, been less travelling, not stayed at hotels, going to restaurants, etc."

Year-on-year organic turnover growth from Orkla's Branded Consumer Goods division

Source: Orkla

At European financial services group Kepler Chevreux, another analyst covering Orkla, Markus Borge Heiberg, had forecast the Toro biscuit maker's second-quarter organic sales would decline 2%. "In my view, I think it was okay. What was a bit disappointing was that, if you look at H1, it's up only 0.7% and that is a bit weak."

Focus on costs helps profits

Amid the volatility in demand, Orkla sought to boost its profitability by controlling expenses. The adjusted EBIT from the group's branded consumer goods operations grew 16% in the second quarter, with margins on that profitability metric at 16.2%, compared to 14.8% in the corresponding period a year ago.

"The underlying progress was mainly driven by cost reductions from profit protection measures in our businesses with lower activity. All business areas except food ingredients had underlying earnings growth," CFO Harald Ullevoldsæter said.

"The positive surprise for me was really the development in profitability and Orkla's very impressive ability to scale down costs and make cost-reductions," Kepler Chevreux's Heiberg reflected. "Overall, it was a solid execution of a very difficult quarter from Orkla."

Questions on Orkla's market share

With Orkla's sales growth slowing in the second quarter, it was understandable when, on the company's conference call with analysts to discuss the numbers, management was asked if it had managed to protect its market shares.

The slowing growth from the overall branded consumer goods operations could in part be explained by the pressure on revenue from Orkla's food ingredients division, with the foodservice channel a key customer.

However, while the company's retail-focused Orkla Foods division saw its underlying sales rise more than 10% in the first quarter, that had slowed to 5% in the second.

Orkla's management pointed out how the decline in the out-of-home sectors in its markets had also weighed on its Orkla Foods arm.

"We maintained our market share, and, in fact, in total, we have increased our market share in foods," Semlitsch said when pushed on whether Orkla had lost share.

Orkla said 80% of the growth seen in Norway's overall grocery retail sector had come from brands, with Semlitsch saying "the biggest suppliers had the biggest growth". He added: "People really go to the trusted and reliable brands, and very often the local brands, during a period like this. We have delivered now very well during Q1 and Q2, but it makes me also confident on the medium- to long-term perspective."

Kepler Chevreux's Heiberg told just-food: "Because Orkla is so complex, I think it's difficult to know exactly how the market shares develop but I think it's credible to believe that they have maintained market shares."

Uncertainty over out-of-home remains

Orkla did not shy away from the fact it felt the impact of a less active out-of-home channel in its markets during the second quarter.

The company's management did suggest the picture was showing improvement, although it wisely remained cautious.

"While we saw a 40% to 60% decline in out-of-home sales in April, the situation improved gradually during the quarter and the sales index was back at approximately 80% to 90% in June but there is still uncertainty going forward," Ullevoldsæter said.

"Our performance will largely depend on how the pandemic evolves and the prevailing government restriction on out-of-home eating."

And, although CEO Semlitsch said trading for Orkla's food ingredients arm in June was "quite encouraging", Ullevoldsæter said the company could have been seeing "some positive effects from the stocking effects in the value chain", with outlets reopening after being closed for a couple of months.

Margin matters

Orkla's margins have been a hot topic among analysts and investors for a number of years and were seen as a priority for Semlitsch when he took the helm last year.

The company has a target, set in 2018, to grow its underlying EBIT margin by at least 1.5 percentage points, after adjusting for M&A and currency, by 2021. In 2018, that figure stood at 11.1%.

Discussing Orkla's first-half results, CFO Ullevoldsæter said some of the cost reductions that had boosted margins are "temporary and related to Covid-19 due to lower activity", pointing to factors such as reduced travel. The company, he noted, had also had to make some temporary lay-offs, which peaked at 1,400 roles in the second quarter.

Ullevoldsæter said Orkla "continued to prioritise margin progress" but added: "The corona crisis may result in short-term priorities which could have a temporary negative impact on margins."

That prompted a number of questions from analysts on how Orkla viewed its margins moving forward.

Asked what those short-term factors could be, Ullevoldsæter said: "This is very hard to estimate because we have our priorities to protect our people and to protect our supply chain. So, it depends on what might happen – and we don't know."

Asked how the market should be thinking about Orkla's margins going forward, he added: "It's very hard to give a precise answer on what is going to continue for how long."

Given the uncertainty around the exact impact Covid-19 could have on the economy and consumer spending – and whether indeed certain countries could see fresh spikes in infections – the responses were understandable but the investment community will continue to watch Orkla's margins closely.

Orkla's shares did rise 1% but sentiment could have been dampened by the lack of visibility about the company's margins. "In my view, [Orkla's] doing better now in terms of reaching financial targets than before the [first-half] report but of course if it's all just a one-off... I understand why the market is cautious in pricing in a high margin now," Heiberg said.

Orkla's "active" M&A agenda

In a bid to inject more growth into the business, Orkla has been busy on the M&A front in recent years, snapping up a number of assets to add to its food ingredients division and buying grocery retail-focused firms and brands in areas such as vegetarian food and cereal.

The company made another acquisition in cereal in June, while the first six months of the year also saw the group offload two businesses.

Before Semlitsch's appointment, Orkla's recent M&A strategy also included the acquisition of a majority stake in Danish pizza restaurant chain Gorm's and the purchase of another in Finland, Kotipizza.

Some Orkla watchers argued more foodservice acquisitions were expected to play a big part under Semlitsch because of the threat from private label in its core grocery retail business.

Asked on the analyst call if Orkla would continue its programme of disposals, Semlitsch said the company would continue to be on both sides of the table. "We will have an active M&A agenda, and that involves also divestitures when we see when that's relevant, combined with acquisitions into our core or adjacent core," he said. "We're not going into details on what's next on our agenda. You can rest assured that we have a constant focus on this, both on the acquisition side but also on the divestiture side."

At Kepler Chevreux, Heiberg believes Orkla could potentially revise its M&A strategy, given the uncertainty around the trajectory of the foodservice market amid the Covid-19 pandemic.

"They could do a step-change, buy distressed out-of-home restaurants and be very aggressive but so far they have not been doing that. I think it's more likely we will see a changed M&A agenda rather than now taking the opportunity to buy cheap restaurants," he said. 

On the analyst call, Semlitsch was asked if he had seen any changes in consumer behaviour that could persist and shape the company's growth strategy. The Orkla chief pointed to the "trust" in local brands and to a fall in travelling. He also believes the growth in the online channel will stick.

"We are taking our fair share of online sales. In some areas, we're also going direct-to-consumer, with some of our strong brands. We're also now established ourselves on the Amazon platform in, for example, Germany."

Speaking to just-food, Heiberg argued Semlitsch's comments on e-commerce were "very interesting", adding: "They have some minor e-commerce websites they have bought before. Their bargaining power in the retail markets that they're in – Norway, Sweden, Finland – they're very consolidated. It's very difficult to see how they can increase their margin without growing into other channels. Reaching consumers directly, via D2C, that's definitely something that will benefit Orkla."