With Norwegian food giant Orkla ‘s organic growth just about ticking over, investors will be keen to see more concrete guidance from incoming chief executive Jaan Ivar Semlitsch, along with greater momentum in margin expansion. Simon Harvey speaks with analysts on the challenges ahead.
A fresh face at the top of Nordic food giant Orkla might be just the tonic to breathe more life into organic growth rates and margins for a company that had largely rested its strategy on M&A under chief executive Peter Ruzicka, who left the Oslo-listed business in May.
Orkla hired Jaan Ivar Semlitsch as the firm’s new CEO this week, but he doesn’t come on board until December, so for now it could be business as usual under interim chief and president Terje Andersen with three quarterly reporting periods still to come before year-end. And after a poor set of annual results last year, investors will be hoping a first-quarter pick-up was not just a blip.
While Orkla’s portfolio is extensive, stretching across bakery, cereals, spices, meals, snacks and pizza supplied to the retail and foodservice channels, its operations are predominately centred on local brands in Norway, Sweden, Denmark, and Finland, where it’s up against rising competition from private label. And despite a deluge of M&A activity over the past few years, the acquisitions have so far failed to get organic growth rates and margins growing with any real fervour.
Martin Stenshall, an equity research analyst at Danske Market Equities, part of Dankse Bank, sets the scene: “The Nordic grocery market is not growing that much with hardly any volume growth – it’s just inflation or price growth, the population isn’t growing that much and we are not eating that much more year-on-year.
“Orkla is facing tough competition from international brands and private label, and with such low organic growth they struggle just to keep up with inflation. So they really need to be tough on optimising the cost base in order to improve the margin. Orkla has underperformed on the operating margin for a long period.”
Some of Orkla’s acquisitions have also raised eyebrows among the investment community, particularly a deal last year for the pizza restaurant chain Kotipizza Group in Finland, with certain circles speculating chairman Stein Erik Hagen was the guiding light behind such transactions rather than the CEO.
But others looked on the Kotipizza deal more positively, such as Markus Borge Heiberg, an equity research analyst at Kepler Cheuvreux . He explained that the chain is the largest in Finland, where consumers tend to eat more out-of-home fresh restaurant pizza, while people in Sweden and Norway tend to consumer more of the frozen variety.
“Of course they [Orkla] see some synergies with their current brand portfolio and with their current positioning,” he tells just-food. “They also have bakery so they make a lot of food ingredients, so you can imagine some synergies in that area as well.”
To his credit, the departed Ruzicka had some success in driving the financial performance through a cost-saving initiative, including plant closures to boost efficiency and productivity. But judging by the slowdown in revenue growth last year, and an uncharacteristic drop in profits, the incoming Semlitsch has some work to do.
For a start, investors would welcome firmer guidance on the organic growth outlook beyond the “at least in line with market growth” proffered by Ruzicka, and who have already been pushing for it, along with better progress on margin improvement. For now, the stock market reaction to Semlitsch’s appointment has been muted, with Orkla’s share price still 20% off last year’s high.
But Heiberg doesn’t expect to see much change in Orkla’s “new” strategy put in motion by Ruzicka under the incoming CEO other than continuing with M&A and striving to bolster profit margins.
“I don’t think they will do anything differently but this guy may be a better fit for a new strategy,” he says. “They want to grow the out-of-home channel so they want to grow in the restaurants, home-delivery channels and also e-commerce (as per their agreement with Alibaba).
“Their current portfolio is not growing fast enough, so they will continue with M&A. I think we will see add-ons in food segments where they buy organic foods and nutrition, and where you see growth to kind of strengthen their brand portfolio. Those will probably be small local brands but also strong brands, but they don’t want international brands.”
Andrew Wood, a Singapore-based senior research analyst at Sanford Bernstein, said in a recent commentary following the 2018 results, that “the margin opportunity is huge”.
“We believe Orkla is a turnaround and strategic evolution story,” he notes. “We remain convinced that Orkla has outstanding potential for value creation, with reasonable organic growth and opportunities for major margin expansion and working capital reduction, which should be achievable with the right management team. We understand the concerns of some investors (and shareholders) who are questioning whether this is indeed the right management team for Orkla…2019 is the year for management to prove that it is.”
Semlitsch is coming into the business from mobile phone and technology company Dixons, but he also has food retail experience from his time at Rema Industrier , which owns the Norwegian chain Reitan Handel. He has also served at Statoil Retail Europe, owned by retailer Alimentation Couche-Tard and which has the Circle-K shops under its wings.
Orkla’s margins have been pretty static over the past few years or so, resting at 11.7% for the group in 2018 in terms of adjusted EBIT, compared to 10.9% four years earlier. And for the Branded Consumer Goods (BCG) division, the mainstay of Orkla’s business, it’s been the same story.
Those margins stood at 11.1% last year versus 10.6% in 2014. And Orkla has a target, put in place by Ruzicka, to improve margins by 1.5 percentage points in the three years through 2021, adjusted for acquisitions, disposals and currency effects.
Stenshall at Dankse tells just-food: “Peter really kicked off this Orkla strategy on how to streamline the BCG division by looking at the supply chain, the logistics, factory fitment, R&D and FX across the group, trying to make one big organisation instead of a very decentralised organisation. The underlying margin has actually improved somewhat but they have also made a lot of dilutive acquisitions like Health and Sports Nutrition Group, Kotipizza and Orchard Valley Foods. The new CEO just needs to continue in that role, or in that line of work.”
When asked to pinpoint the key areas for improvement, Stenshall said: “To implement measures to spur organic growth, coupled with getting the adjusted EBIT margin up for the Branded Consumer Goods division, which has primarily been the focus of the previous CEO. That’s key I think.”
Danske’ own estimates put the adjusted EBIT margin at 11.9% this year for BCG, rising slightly to 12% for each of the following two years.
And Heiberg at Kepler Cheuvreux believes the 1.5 point margin improvement is achievable as long as Orkla gets organic growth moving at a better pace.
“By closing factories and improving productivity, then margins will improve,” he says. “With organic growth you will also have margin expansion, so we think there is a lot of potential in this cost-cutting initiative. We think it [the target] is achievable. We have seen some promising progress in Q1 – the rolling 12-month EBIT margin was up 80 basis points.”
It appears organic growth might be headed in the right direction too, and paramount for the incoming CEO will be maintaining the momentum, notwithstanding the three quarterly reporting periods yet to come before he takes the hot seat.
Annually, organic growth was 0.2% last year, a poor result compared to the 1.6% figure the previous year and the even bigger number of 2.5% in 2015. However, the first-quarter print registered at 0.9%, an improvement on the 0.8% decline in the prior three months.
Dankse forecasts a 1.9% organic growth rate for the current quarter and 1.6% for 2019. The equity research house also envisages a tail off next year to 1.5%, before recovering to 2% the following year.
Stenshall presented his own question to himself when asked about progress in margins and organic growth rates.
“Should it [margin] actually be 15% or 18%? It’s a complex question because of the supply logistics and they are trying to reap measures to reap cost efficiencies and have been doing so for the fifth year now, but the margin is just slightly up.
“I forecast very modest organic growth going forward of 2%, and a rather flattish margin development for the next two or three years.”
And the caution is understandable given the operating landscape for Orkla is likely to remain challenging, with the continuing onslaught from private label not expected to dissipate anytime soon. M&A will presumably form a key component of Semlitsch’s strategy, but what remains to be seen is where he chooses to invest the company’s money in terms of food categories and channels.
However, more foodservice acquisitions are expected to play a big part because of the threat from private label, which Heiberg says is the company’s “biggest concern”.
To get around it, Orkla undertakes acquisitions often, shifting “their strategy to try to capture growth and capture synergies”, he adds.
Heiberg continues: “Private label captures about half the growth in the grocery channel in Norway, Sweden and Finland of around 2%. But private label will take half of that growth, so Orkla would be 1%, and 1% is not sustainable.
“What we need to see is organic growth strengthening, and also they have an ongoing cost-efficiency programme where they are closing factories, so we want to see the operating margin improve.”
If Orkla’s recent history is any guide, the investment community is unlikely to get what they want from the new CEO – a firm organic growth target. On the one hand, such a move would provide a benchmark for the company’s performance, but on the other comes with its own risks, with last year’s performance a case in point. But then life is full of surprises.
And can the market expect to see more acquisitions within the realms of the frowned upon Kotipizza deal? Heiberg thinks so.
“It’s difficult to understand when you first look at it [Kotipizza], but when you start looking at the market growth and the market perspective and Orkla’s position, it’s difficult to imagine how else they can grow.”