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UK food group Northern Foods saw its shares fall again today (2 June) after yesterday reporting flat annual sales and earnings. Concern over dividends has weighed on the stock and, as Northern continues to restructure its business and launch major brand initiatives, there are questions over where the company is heading.

Northern Foods is a company in a state of flux.

The UK group, owner of Goodfella’s pizza and Fox’s biscuits, as well as private-label interests in convenience food, saw its shares fall again today (2 June) after yesterday’s annual results pushed down the company’s stock.

Northern reported flat annual sales and earnings for the year to 3 April and concern over the company’s future dividend concerned investors and sent the group’s shares down more than 5%.

The business saw its shares fall again today – the stock was down more than 2% at 12:42 BST this afternoon – and, despite the company’s management insisting the intention was “not to reduce the dividend”, there are questions hanging over the company from a financial and an operational perspective.

Northern’s pension deficit more than doubled in its last financial year to GBP150m (US$219.2m) before tax and concerns that the company will have to divert cash from any dividend payment to top up its pension pot weighed on its shares.

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Meanwhile, Shore Capital’s Darren Shirley says he wants to see EBITDA rise “sustainably” and for “cash cover to build” before the stockbroker “gets behind the dividend stream argument”.

Shirley says the yield on Northern’s final dividend is 6.3% and, unfortunately for the company’s investors, he argues that is unsustainable.

“We do not see such a yield as being sustainable; so either the dividend is cut or the share price re-rates,” Shirley says. “For now we sit somewhat awkwardly on the fence on this matter but we sense in 2010/11 we will be making a more forthright stance either way.”

To support Northern’s dividend, the company needs to ensure earnings tick along nicely. In the year to 3 April, underlying pre-tax profits inched up 0.5% to GBP39.2m, although profit from operations was up 3.6% at GBP54.6m and its free cash-flow – before restructuring – stood at GBP53.6m, against GBP35.4m a year earlier. Northern was also able to bring down its net debt from GBP206.7m to GBP183m.

Such numbers leads Shirley to argue that Northern, a company that has undergone much restructuring in recent years, still has a “strong constitution”.

He explains: “In terms of debt management, the group completed a US$100m private placement in May and GBP250m of credit facilities are in place to mid-2012, so it is fair to say that management should not be looking over its shoulder so long as the operating company remains sound, and to be fair, through all of the recent challenges, it has managed to do so.”

Looking at Northern’s three key divisions – chilled, frozen and bakery – the company had a mixed 12 months, a year in which the company continued a restructuring programme.

Underlying revenue from the chilled business was up 6.4%, although profits fell 16%. Frozen sales were down 9.6%, although profits jumped 46% as Northern quit lower-margin business. In bakery, sales and earnings were both up, thanks largely to Northern’s branded and own-label biscuit stable.

The mixed results cause some confusion over where Northern is headed operationally and those questions will persist with the company planning to close a ready-meals site in Swansea – and pinning its hopes on a major relaunch of Goodfella’s pizza.

Nicola Mallard, an analyst at Investec, points out that the Swansea closure will “weigh on the revenue progress” seen from Northern’s chilled division. She also raises concerns over Northern’s frozen earnings despite the profit hike last year.

“Margins started to recover, but at 5.3% [they] are still too low for a predominantly
branded business,” Mallard writes in a note to clients. “The Goodfella’s pizza range has been relaunched, starting in the fourth quarter of fiscal 2010, and the costs of this, we have been warned, will weigh on the first half of fiscal 2011.”

Northern did not give too much away when giving its outlook for the next 12 months. The company said it would see higher costs linked to initiatives like the Goodfella’s relaunch in the first half of the year but, more broadly, said only that “challenging market conditions” would continue but insisted it was “well positioned for the future”.

For Shore Capital’s Shirley, Northern chief executive Stefan Barden has “set out a simple strategy” for the business – including like-for-like net sales volumes of 1-3%, single-digit margins that the stockbroker deems to be 6-8% and gaining market share.

“The key deliverable will be the translation of his excellent ideas into meaningful applications,” Shirley says. “Much work has been undertaken to reach this position; indeed Mr. Barden speaks of completing three years of restructuring with the implication being that, from the second half of the current financial year, there will be some form of ‘break out’.”

Shirley adds: “So, the teams are in place, the focus on cash management is drilled into the culture and operation of the business and cost competitiveness is deemed to be sound.”

However, the Shore Capital analyst says further work at Northern is required and the company “needs a fair wind” in the second half of the year to meet the stockbroker’s forecast of annual current pre-tax profit of GBP40.4m.

“We continue to sit on that sharpening fence with a somewhat uncomfortable ‘hold’ stance on Northern Foods’ stock,” Shirley says. “Northern Foods, therefore, is one to watch with considerable potential upside – but does not require action just yet.”

It seems, then, that we will have to wait well into Northern’s new financial year to have a clearer idea about whether the company’s restructuring and brand initiatives are bearing fruit.