This week’s profit warning from Premier Foods plc dismayed the market with analysts expressing concern about the UK group’s ability to pass on Brexit-linked cost increases, the performance of its brands and its promotional strategy.
In May last year, Premier Foods plc issued a set of results that indicated that, perhaps, the UK group, after a tumultuous few years of debt pressure, asset disposals, weak sales and changes in CEO may be on a solid footing.
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Okay, Premier’s board came in for some criticism in March and April for rebuffing the takeover offers from US spices and seasonings giant McCormick & Co., but there did appear to be signs the Mr Kipling maker’s strategy of investing in fewer brands was working, while the company’s stronger underlying performance was enabling it pay down debt.
However, during the back half of 2016, there emerged indications of pressure on Premier’s top line. In October, Premier booked a 5% fall in revenue for the second quarter of its financial year, with the company pointing to the warm weather seen in the country in September, saying it had hit categories such as gravy mixes and desserts.
A month later came numbers that showed a fall in Premier’s sales and earnings for the first half of its financial year. However, Premier maintained its profit forecasts and said it had been able to make progress in tackling issues around its pension costs – an area of the business that is of concern to investors.
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That Premier was able at that point to stick to its profit forecasts was interesting, given it and its UK food manufacturing peers had seen the value of sterling plunge in the wake of the country’s vote to leave the EU, meaning there would be upward pressure on the cost of a range of inputs on the horizon. Speaking to analysts in November, Premier CEO Gavin Darby intimated the company might have to up prices but said it would first look at areas such as depth of promotions or pack formats. “If you’ve worked your way through that sequence, you take price increase brand by brand and category by category for whatever remains. A blended approach would be a good summary of Premier’s strategy,” he said. In all, amid the mood of pessimism that was pervading the UK food industry about the possible consequences of Brexit, one or two more pragmatic voices emerged – and one of those was Darby.
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By GlobalDataWhat Premier Foods CEO Gavin Darby thinks about Brexit – analysis, published in November 2016
However, fast-forward to yesterday (18 January) and Premier issued a profit warning, news that curdled the shares of the Ambrosia custard maker. Darby said Premier’s trading profits for its 2016/17 financial year would be “approximately 10% below previous expectations”. He said it was taking Premier longer than it had expected to recover the increases in its costs and pointed to “weaker-than-expected” sales during its third quarter. The performance of the company’s categories was, Darby cautioned, expected to “remain challenging” in the fourth quarter.
In a bid to boost profits, Premier is to start a “new cost-saving and efficiency programme”, which he said would “deliver GBP10m from 2017/18 with equivalent further savings the following year”, Darby said. He underlined the savings would also be used to invest in the company’s brands.
The sales performance of Premier’s brands was mixed during the third quarter, which ran to 31 December. Sales fell 1% to GBP251.4m. Premier’s brands reported a 3.8% decline in sales. The company’s non-branded business saw its sales grow 11.6%. Volumes increased 3.4%. Darby said six of Premier’s “eight major brands” had gained market share.
However, Premier admitted it had been hit by the changing promotional strategies at its major retail customers. The UK market has seen a fall in multi-buy promotions as the country’s Big Four have sought to counter discounters Aldi and Lidl, which focus more on every-day-low-pricing. Premier said it had reacted by using “reduced price deals” more but said those types of promotions were “more costly” than multi-buys and lead to reduced sales per unit.
There are concerns about whether and how long it will take Premier to adapt its strategy on promotions to the current needs of their retail customers. “You’re going to have a period of disruption,” Davy Stockbrokers analyst Declan Morrissey said. “It’s not to say the big retailers might do a U-turn on this in six months time and go back to BOGOFs. I don’t buy that it’s a one-time effect. It’s just the way Premier were overly-reliant on this one type of promotional strategy, or one strand of promotional strategy. It has to be more broad-based from here so they don’t feel the effects of disruption like this again.”
Jefferies analyst Martin Deboo described the share gains for the six brands, as well as Premier’s international growth and the company’s statement its talks with Mondelez International to extend its licence for Cadbury cakes, as “silver linings”.
However, he added: “Input costs are inflating by mid-single digits. Premier is in intense negotiations with retailers on pricing and promotion, but there is no certainty around the outcome. Cost recovery lags now seem inevitable. A shift in the climate away from volume-enhancing multi-buys and in favour of pure price discounts is hurting volumes and margin.”
More broadly, Premier’s announcement yesterday has caused some to question the underlying strength of the company’s portfolio.
Darren Shirley, an analyst at stockbrokers Shore Capital, cut his stance on Premier’s shares from ‘hold’ to ‘sell’ on the back of the sales update and profit warning. He said Premier’s third-quarter sales numbers were an “improvement on the disastrous Q2 update” but added: “Such sustained weak trading leads to increasing concerns around the growth credentials of Premier Foods’ categories and the strength of the group’s brands within the categories – noting that whilst management has delivered a range of NPD and innovation across its brands, which we applaud, such actions have singularly failed to gain traction with consumers. Such concerns on the strength of the portfolio are heightened by the fact that negotiations around the recovery of broad-based input cost inflation are taking longer than originally foreseen.”
Shirley, meanwhile, said Shore Capital had “increasing concerns” Premier’s cost-saving plans would be “quickly absorbed and will not lead to any recovery in margins”. And, reflecting on how Premier has long been seen by some in the investment community amid its various challenges, he added: “Following on from the disappointing Q2 update when management announced it would be cutting back on marketing spend in order to protect profitability, commercial suicide for a consumer goods company in our view, today’s update represents a material increase in our concerns surrounding Premier Foods’ ability to recover from its long-standing ‘zombie’ status.”
Last spring, some Premier investors likely saw a takeover by McCormick as a chance to end their investment in the UK group with a decent return. McCormick’s final indicative bid for Premier, tabled on 30 March, valued the company’s shares at 65p. In the wake of its profit warning, Premier’s shares closed yesterday at 43p. At the time of writing, they stand at 41.5p.
It would not be a surprise if Premier’s board – and therefore management – is feeling some heat from its investor base. The Financial Times reported yesterday one investor, US hedge fund Paulson & Co., has publicly called for Premier to be sold, arguing it had been “grossly mismanaged”.
“Two sequential warnings, following the termination of discussions with McCormick around an indicative offer of 65p per share, will increase pressure on the board and management to identify radical choices to improve performance,” Jefferies’ Deboo reflected.
And for investors perhaps believing the slump in Premier’s share price could present an opportunity for a suitor to come in for the business, Shirley added: “Whilst possibly viewed as a potential suitor, Nissin Foods Holdings (with a 20% stake) also acts as a poison pill for other potential suitors, so we see little scope for an attractive premium bid.”
