Lindt & Sprüngli cheered financial markets today (23 July) after the chocolate maker’s first-half earnings and an improvement in its key North American division. Simon Harvey takes a look at developments.

Lindt & Sprüngli announced a set of positive first-half results including a pick-up in the Swiss chocolate manufacturer’s troublesome North American market where profit margins have been under pressure in recent years.

The Zurich-listed business reported 6.2% growth in group organic sales today (23 July) led by the rest of the world segment – where it has launched into new markets in Japan, China and Brazil – closely followed by North America. In the US, the world’s largest chocolate market, Lindt raised prices during the half, while in France it faced difficulties arising from price pressures linked to its competitors.

Finance chief Martin Hug, speaking with analysts on a follow-up earnings call, says worldwide markets for chocolate are “recovering slightly” and are showing signs of “positive momentum”, although he conceded the trading environment remains “tough”. And Lindt was not helped by a new accounting standard related to leases – known as IFRS-16 – which shaved CHF4m (US$4.06m) off its net income of CHF88.1m, and forced the company to restate its debt upward of CHF500m.

Hug says Lindt implemented price increases in the US in the first quarter with the “most positive impact” coming from its namesake chocolate brand and that of Ghirardelli. Further price hikes could follow depending on developments in the cocoa market but the US will probably see the “fastest price increases” followed by Europe, he adds.

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Growth in the US was driven by volumes, which is why Lindt is investing in new production lines at its plant in Stratham, New Hampshire. Capital expenditure in the site is expected to exceed CHF200m over the next three to four years to support the increase in volumes and hopefully to gain market share, Hug says.

However, profit margins in the North America business – measured by EBIT – have still not recovered to the levels they were at a few years ago, although Hug says they should “go up slightly” compared to last year. But the finance chief was pinned down during the Q&A session and asked to give an indication of when they will return to the 13% levels seen in recent years.

“It’s probably not where we want it [margin] to be,” Hugs answers. “Last year, I think it was around 8%. When will it be back to 13%? It’s difficult to say. It depends on many things. 

“We will see some positive impact from operating leverage, and then on the flip side, it also depends on how much we want to invest in the brands in the US. Hypothetically, if the other two segments stayed flat and if you want to grow 20 basis points per year you need to grow about 80 points per year in North America roughly, because its about 40% of the business.”

First-half organic growth in North America came in at 7.2%, faster than the group as a whole, but slower than the 8.3% seen in the rest of the world region.

Nonetheless, Andrew Wood, a research analyst at Alliance Bernstein, said Lindt’s performance in its NAFTA division, which includes the US, was improving.

“After a turbulent couple of years, momentum continued to improve in NAFTA, with growth accelerating strongly over H2 2018 (+2.2%) to its highest level for four years, since H1 2015,” Wood wrote in a note to clients. “All three businesses contributed positively to the performance: Lindt outperformed the market, Ghirardelli delivered growth and, importantly, Russell Stover returned to positive territory, driven by the relaunch of its Bow Line pralines and good performance in the new sugar-free range. Encouragingly, the trading environment improved in the US in H1.”

Sales in Europe grew 5%, another result within Lindt’s overall full-year target of 5% to 7%.

During the first half, Hug notes a “good performance” in Germany, the UK, Austria and Scandinavia, while the Eastern European countries grew by double digits. In terms of sales targets for 2019, the company is predicting 8-10% growth in the rest of the world, 4-5% for North America and 5-6% for Europe.

“The significance of the ‘Rest of the World’ segment for the Lindt & Sprüngli Group is growing year by year,” the company’s earnings commentary stated. “The growth and sales strategies are tailored to local consumer preferences and paid off especially in Japan, Brazil and China. These markets benefit from the groundwork of previous years and the increasing market presence of premium chocolate products.” 

But group EBIT margins were partially hit by IFRS-16, and would have registered at 20.3% instead of the actual 14.4% if the new international financial reporting standard was excluded, Hug explains. 

Alain Oberhuber, a consumer goods analysts at MainFirst, said he expects financial markets to raise estimates on the back of Lindt’s “stronger” first-half organic growth.

Commenting in a research note to clients, Oberhuber said: “We expect consensus organic growth estimates to rise to 6% for fiscal year 2019, versus current levels of +5.4%, and our +5.7%. This is mainly due to stronger growth in North America. Europe will grow as expected but with a stronger Germany, UK and Swiss business, and some disappointment in France. Finally, we expect that the long-term growth rate could be at the higher end of the company’s guidance, with an organic growth rate of 5-7%.”

Europe growing but France “tough”

Within Europe, Hug says France is growing at a low-to-mid single-digit pace, in line with its expectations. However, the country is a “tough market” where Lindt is facing price actions from its competitors. 

In France, “all our competitors tend to be quite aggressive on price”, he adds. “We try not to be aggressive on price. We do not want to do more promotions, we do not want to bring our list prices down despite the fact there is a lot of pressure from the trade. Of course, in a period where you have low cocoa bean prices you cannot completely ignore the pressure, you sometimes have to give in, but in general our price has remained much more stable than the ones of our competitors. In this market where it’s really challenging, I think growth of low-to-mid single digits is what we have to expect.”

Hug explained it is easier for Lindt to take on pricing in its Rest of the World markets but is not so straight-forward in parts of Europe where negotiations tend to take a long time and are often rejected by the retailers. In other geographical areas, Lindt is having to adjust to volatile exchange rates and so price increase are more the norm.

He added: “Europe is a mixed bag. You have some markets in Europe which are affected by very volatile currencies like Russia. You are constantly doing price increases depending on the currency. And then you have the more stable market related to the euro. There it’s a bit more difficult. In France it’s very difficult to do price increases and you have other markets where it’s a bit easier. But in Europe I would not expect massive price increases.”

Ultimately, for global chocolate manufacturers, decisions behind price adjustments are swayed by the vagaries of the commodities market and particularly cocoa.

Hug says Ghana and the Ivory Coast supply around two-thirds of the global market, although Lindt also sources the base ingredient from Ecuador, the Dominican Republic, Papua New Guinea and Madagascar.

“The more we grow the more we will diversify the origin,” Hug says. “For now, let’s say for the next few years, Ghana will remain important and also in the future after that.”

Interestingly, in Lindt’s earnings statement, the company also provided an update on the Lindt & Sprüngli Farming Program, another example of a major food manufacturer flagging sustainability efforts in its financial reporting. The programme, established in 2008, takes in Ghana, Ecuador, Madagascar, Papua New Guinea and the Dominican Republic and is “showing a positive impact there”, the company said.

The company said it is on target to have a 100% traceable and verified supply chain for cocoa beans by 2020.

“Today, 86% of the sourced cocoa beans are already traceable and externally verified,” according to the earnings commentary. “Lindt & Sprüngli has realigned its sustainability strategy as it steps up its efforts in this area, and has formulated new concrete commitments. One of the aims is the ‘no-deforestation’ commitment which states that by 2025 the entire cocoa supply will be sourced from areas free from deforestation.”

On an organic basis, Lindt’s sales growth has melted somewhat in recent years – dipping to 3.7% in 2017 amid its struggles in the US – but the company’s top-line performance in the first half of this year builds on something of a recovery in 2018.

After today’s generally positive set of results, investors will obviously be eyeing Lindt’s second-half performance to see if the momentum can be maintained, particularly in North America and importantly the US. And markets reacted by pushing up the stock by more than 2% on the Zurich exchange by mid-afternoon in Switzerland today, taking the shares up around 13% for the year so far.

In all, it’s proved a better day for Lindt than 15 January this year when, in a surprise move, the Lindor maker cut its guidance for mid- to long-term organic sales growth, sending its shares price down 4%. At the time, analysts at Bank Vontobel described the change as a “kind of revolution for Lindt,” given the company had had the same guidance on that metric for a decade. With the first half of 2019 building on the growth seen in 2018, shareholders will be cheered.

Bernstein’s Wood added: “Lindt’s stock has under-performed the market and most of its peers year-to-date, following the cut in long-term sales guidance from 6-8% to 5-7%. We expect investors will react positively to the good organic operating growth, especially on the top-line … and perhaps close the gap.”