Orkla ASA
Q2 2021 Earnings Call Transcript

Published: 15 Jul 2021

[Kari Lindtvedt:]

Good morning, and welcome to this presentation of Orkla’s second quarter results. My name is Kari Lindtvedt, I’m Head of Investor Relations at Orkla. We start today with CEO Jaan Ivar Semlitsch, who will summarize the main points of this quarter. Then CFO, Harald Ullevoldsæter, will give you some more detail on the financials. Before we move on to Q&A, Jaan would like to share some reflections on the outlook. Throughout the presentation today, you're welcome to post questions on the web and we will address them at the end of this session. That's it for me for now. I would leave the floor to Jaan.

[Jaan Ivar Semlitsch:]

Thank you, Kari. Good morning and thank you for joining us on this warm and sunny day here in Oslo. It's been six volatile quarters following the corona virus pandemic. And overall, I believe Orkla has good momentum and what seems to be further normalization of everyday life. Although this situation in many areas simply serious, more and more people have been vaccinated and we see infection rates decreasing in our main markets. Restrictions are being lifted and out of home channels are gradually opening up. We also expect demand in the grocery channel to normalize going forward. Our factories are running efficiently. And we are managing and maintaining good service levels in line with our priorities. Today, we can report group EBIT growth of 5% in the quarter. The improvement is mainly driven by good results for hydro power, as a result of high power prices and recovery in the out of home channel. On the other hand, despite our top-line growth, I'm not happy with the negative profit performance in branded consumer goods. And of course, we'll come back to this in more detail. Adjusted EPS for the quarter was NOK 1.14, an increase of 4% and the year-to-date adjusted EPS was NOK 2.40, an increase of 12%. On the next slide, I want to reflect on some of the highlights for the quarter. In Q2, we delivered 6.9% organic revenue growth, although against relatively weak comparables last year. And I'm happy to see that the development in the quarter is mainly volume driven. That said, I'm not satisfied with the fact that on an overall level, our market share development is weak. Orkla strategy is that strong number one or two positions in local markets and going forward will focus on turning this development. On a more positive note, we see that as restrictions related to the coronavirus pandemic are lifted volumes are coming back in the out of home channel. Especially Orkla food ingredients has experienced strong volume recovery in all segments in Q2. Several categories are still supported by positive market development following the pandemic but in Q2, we see these effects starting to diminish. And of course, we expect this trend to continue going forward. Underlying EBIT adjusted development for branded consumer goods including HQ was minus 6.6% in the quarter. Foods, confectionery snacks and care all delivered negative performance, but partly offset by food ingredients and consumer investments. Relative to organic top-line growth of 6.9%, we are not happy with this performance. Although and this is important it must be seen in relation to the profile last year. The main drivers for weak profit conversion are the ERP project in food Sweden, higher fixed costs due to higher activity level, India against strong comparables last year and some facing of non-periodic items. And Harald will in his presentation share more details. But before that, I would like to make a few comments on some of our strategic growth initiatives and M&A activity this quarter. In our Q1 presentation April this year, we announced three prioritized platforms for growth. And since then, we have organized our plant-based initiative in a separate business unit. Our ambition is to become one of Europe's leading players in the alternative protein space by 2030. The competition is tough, with several players willing to commit and invest substantial amounts. Brand building is the core of our class operations. We will leverage and continue to leverage our local insight into taste and consumer preferences in further strengthening our plant-based positions. And we have most recently invested in production facilities at both our factory in Eslöv in Sweden, and Grønvang in Denmark. Moving on to our out of home initiative, we have just announced the acquisition of New York Pizza, a leading Dutch pizza delivery and takeaway chain. I'm also happy to see that Kotipizza continued to deliver growth in the quarter and volumes are returning to the food stock business. And as mentioned on a more general level it's great to see food services and the out of home channel recovering. And then, regarding health, Møllers cod liver oil continues to grow both domestically and internationally according to plan. And during the pandemic, the health category has experienced exceptional market growth probably not seen before. Consumers have become more focused on health and strengthening their immune system. We strongly believe this trend will continue post-corona and I must say I believe this is a great opportunity for Orkla. During the quarter, we have also completed the acquisition of NutraQ, which will support our ambition in this very important category. My next and final slide, I would like to summarize our M&A activity during the quarter where we have completed several transactions. As mentioned, we announced the acquisition of New York Pizza in June. We believe the out of home channel has strong fundamentals and significant growth potential. The European market for fresh takeaway pizza is fragmented and we know the pizza category very well. There are several local players and only a handful of bigger ones. And with the acquisition of New York Pizza, we are positioning Orkla to become a significant player in this segment. The integration of Eastern has started somewhat challenged by the pandemic. But we believe in impact of Eastern, the impact has been severe in the southern parts of India during the last few months. Most of our employees have now been vaccinated. production is running efficiently and the infection rates seem to be slowing down. We very much believe in the potential for our Indian investment. The acquisition of NutraQ was completed in June. So far this year NutraQ has delivered good top and bottom-line growth and management are really motivated to be part of the journey ahead with Orkla. I look forward to see NutraQ developing and growing its direct-to-consumer business together with Orkla Health. Since Q1 we have also acquired the remaining 80% of the shares in Nói Siríus, a leading confectionery brand in Iceland. Furthermore, Orkla food ingredients continues to strengthen its position in Europe with the acquisition of Cake Décor and For All Baking in the U.K., Seagood in Norway and Hans Kaspar in Switzerland, which we announced this week. I will now hand over the floor to Harald, who will give us the details for the quarter.

[Harald Ullevoldsæter:]

Thank you, Jaan Ivar and good morning everyone. Let’s have a look at the financial performance for quarter two. Reported revenue growth for Orkla Brand consumer good was 5% in the quarter. However, earnings for branded consumer goods including headquarter declined by 66 million, 5% in the same period, and I will come back to this. Improvement for industrial and financial investment was mainly driven by high power prices for hydro power in the quarter compared to exceptionally low prices last year. We had net recording, non-recurring items of minus NOK 118 million in the quarter, mainly related to M&A cost and restructuring and ERP. Profit from associated improved by 7 million from last year mainly related to Jotun. Adjusted earnings per share increased by 4% in the quarter and 12% for the first half year. Let's have a look at the cash flow performance for the first six months. Cash flow from operation was NOK 1.447 billion for the first six months. The decrease from last year was primarily driven by higher net working capital this year. 2020 was positively affected by deferred payment terms for indirect taxes from quarter two to quarter three. Underlying improvements in average net working capital in percent of net sales value is still positive, but with a lower rate of improvement compared with last year. Replacement investments were in line with corresponding period last year and primarily related to factory projects. The larger project is the ongoing construction of the biscuits factory in Latvia. Now let me walk you through the net debt rates for the first half year. Net debt including leasing increased by NOK 7.5 billion to NOK 13.9 billion end of first half year. The main cash out was over the six month period was related to the acquisition of 67.8% of Eastern in March, and NutraQ in June. Share buyback and dividend payments account for NOK 3.1 billion cash outflows in the first half of the year. Orkla still has a strong financial position and our debt level at the end of quarter two corresponds to approximately 1.8x EBITDA based on the last 12 months, including our recently announced acquisition of New York Pizza, the level increases to 1.9x EBITDA, and this is well within our ambition not to exceed 2.5x EBITDA over time. Let's have a closer look at the performance in branded consumer goods. As usual, I will start by presenting the overall picture for branded consumer goods and then I will take you through the individual business areas. So let's start with the top line performance for branded consumer goods. As you can see from the graph to the left reported revenue growth from our branded consumer goods business was 5%. Organic revenue growth added 6.9% in this quarter, compared to minus 3.8% organic growth for the same quarter in 2020. And this gives a CAGR from 2019 P-Corona of approximately 1.4%. Structural changes had a net positive impact of 4.1% that were offset by negative Forex translation effects of 6% mainly from a stronger NOK versus both Euro and SEK compared to a weak NOK in the first half of 2020. As you can see from the graph to the right, organic revenue growth was 3.7% for the first half year, compared to 2.7% organic growth for the same period in 2020. This gives a CAGR from 2019 of approximately 2.1%. Moving on to growth per business area. As you can see from the graph to the left, organic revenue growth was 6.9%. This quarter, but with large variation between the different business areas. The general picture is that the wide fluctuation observed across most markets since March last year, with weaker sales out of home channels and strong growth in sales to the grocery sector are gradually normalizing. In the second quarter, we experienced positive effects in out of home channels from reopening of most European countries, especially within Orkla food ingredients. Our house care business and consumer investments is still positively impacted by strong market growth following Coronavirus effects. We see this trend starting to diminish in quarter two as comparables increase and growth in demand is flattening. In the grocery channel, we still are seeing sales at the same level as last year. But we expect a decline on a year-over-year basis in the second half of 2021. Let's have a look at the profit performance in branded consumer goods including headquarter. EBITDA adjusted for branded consumer goods including headquarter declined by 5.4% in the quarter, reflecting a 6.6% underlying decline. For the first half year we had an underlying EBIT growth of approximately 1%. So the underlying decline in EBIT in the quarter is mainly related to timing of Easter sales, which applies both through confectionary and snacks and foods. Reversal of accruals in confectionary and snacks last year, as we mentioned, higher fixed cost partnerships explained by lower activity last year, and increased costs related to implementation of a new ERP system in Orkla Food Sweden. And as Jaan Ivar said, profit declined in India, driven by both a stockpiling effect last year quite strong. And then also challenging Coronavirus situation in quarter two. Orkla is exposed to a broad range of raw materials, the pandemic has led to bottlenecks and supply chain issues globally. Together with strong demand, this has led to a strong increase in raw material prices, particularly for vegetable oils, grains, meat, vegetable, and diary and packaging. So far in 2021, the currency effects has offset part of the raw material increases. Orkla exploits scale advantages through centralized procurement function. For several of our major raw material categories, we have medium to long-term contracts. The length of the contracts vary, but typically duration is six to 12 months. Several of our input categories are sourced locally and do not always follow the fluctuation in commodity markets indexes. Historically and overtime Orkla has been able to get compensated for commodity fluctuations by means of price adjustments. This work will continue in the coming quarters. But due to contractual agreements on the timing of price changes either or nor the grocery sector, there will be some facing difference. In effect of Orkla's price changes in the short-term. To add some flavor to our raw material exposure. In total, the cost of raw material finished goods and packaging is equivalent to approximately 50% of revenue in branded consumer goods. Top five categories, which is vegetable oil, grain, dairy, meat and packaging, make up approximately 1/3 of total material costs. Orkla's exposure to a euro is approximately NOK 4 billion, 15% in NOK and 15% against SEK and approximately NOK 0.5 to U.S. dollars. And as you can see from the graph on the right-hand side, the EBIT margin improved by approximately 20 basis points on a rolling 12 months basis, while the underlying development in a 12-month period is flat. And year-to-date reduced by 30 basis points. In total, the A&P spend year-to-date is in line with last year, but we still expect A&P spend this year to increase approximately in line with the increase we saw in 2020. Now let's have a look at performance by business area, starting with Orkla Foods. Orkla Foods organic growth was 3% in the second quarter. This was driven by sales growth in most markets excluding India and Norway. MTR in India had a strong quarter last year due to stockpiling. This quarter the southern part of India has been severely hit by lockdowns and closed shops due to a new wave of Coronavirus infections. Denmark, on the other hand was particularly strong. We are experiencing that volatile sales growth patterns including the mix between out of home and grocery are gradually normalizing. Orkla Foods Sweden launched a new ERP system at the beginning of the year. The implementation has been successful but has continued to limit activity levels and affected cost negatively in the quarter. In quarter two, we had some costs in addition to the previously communicated permanent cost increases. The costs are related to temporary employees supporting the processes mainly within production and logistics. We expect the external cost increase to be reduced during 2021. The permanent cost increase related to the new ERP system in Sweden is estimated to be approximately NOK 80 million on a 12-month basis. Lower costs related to the coronavirus pandemic last year also experienced some of the earnings reduction. Increases in raw material costs have continued this quarter. But this has been offset so far by strong NOK and revenue management. Moving on to confectionery and snacks. Our confectionary and snacks next business had organic sales decline of 1.2% in the quarter. Non-periodic items related to a reversal of accruals from 2019 had a positive impact on both organic sales and earnings in the same quarter last year. While the positive Easter effect we mentioned in quarter one, this year had a corresponding negative impact in quarter two. Adjusted for these two above mentioned effects, we estimate the underlying organic growth rate in the quarter to be more or less in line with the full year 2020 around 2%. We continue to see good market growth but lower than level seen in 2020 and in quarter one 20 21. Going forward this is expected to diminish further. Higher raw material costs particularly for vegetable oil and packaging coupled with somewhat higher fixed costs due to low activity level in 2020 had an adverse impact on EBIT and margin development. Let's have a look at the performance in Orkla Care. Orkla Care has seen organic revenue growth of 2.5% mainly driven by health, wound care and HSNG. Orkla Health continued to report good sales growth, particularly in the category of omega three and VMS. Our online supplier of sport nutrition products HSNG also saw a strong sales growth in the quarter. Wound care had a comeback from low levels in 2020 with increased retail sales in both grocery and the pharmacy channel and addition to increased business to business sales. For the quarter EBIT, adjusted declined by 13%, mainly related to negative mixed effects lower revenue from industrial sales from a back of high sales last year. Additionally, we had high fixed costs and increased ANP costs in the quarter. The profit conversion trend in the past quarter is not satisfactory, and we will continue to focus on improving this. Let's turn to Orkla food ingredients. Organic sales in Orkla food ingredients grew by 20.5% in the quarter as restriction eased and activity increased in the out of home segment. However, this compares to a weak corresponding figure last year. Growth was broad based in terms of both business units and geographies. Total sales are now comparable with level seen before the pandemic, while some segments are still below historical levels, particularly within tourism, hotels and conferences. Margin improvement is largely explained by improved scale on the existing cost base. Now let's have a look at the performance in consumer investments. Organic sales grew by 13.2% in the quarter. Sales in the painting tool business continued to be positively impacted by high activity and do-it-yourself segments and grew 5% organically. But growth turned negative in June, when the business faced stronger comparables. Higher inputs and freight costs are putting negative pressure on earnings. Our restaurant business including pizza in Finland had another strong quarter with 21% organic growth driven by recovery in wholesale sales to external customers. The pizza chain sales were moderate as the broader restaurant market reopened and comparable figures increased. The majority of the consumer investment portfolio will face strong comparable financials in the second half of the year. I will end my presentation with some comments on Jotun. Jotun had sales growth in the quarter in three of the four segments while marine coating experienced decline in sales towards the end of the quarter, due to cyclical fluctuation within shipbuilding, particularly affecting South Korean yards. Earnings were slightly reduced in marine coating and overall gross margin decreased. Raw material prices increases put pressure on margins in quarter two, and will continue to do so in the coming quarters. All segments have started to implement price mitigating measures. This concludes my review of the quarter, and I will leave the floor to Jaan Ivar for his final remarks.

[Jaan Ivar Semlitsch:]

Thank you, Harald. As I said in my introduction, and as Harald has elaborated, we are not satisfied with a weak profit conversion in the quarter. On the positive side, I'm glad to see volumes returning to the out of home channel. As we move into the next phase of the pandemic, we expect consumer habits to shift once again, as society opens up. Along with the positive elements of reopening, we do see certain headwinds in the second half of the year. Imbalances and price increases within raw materials will increasingly influence our operations. That said, commodity markets are volatile in nature, over time, Orkla's history of successfully adapting to input cost changes through price adjustments and other measures. But I must say the current volatility is higher than normal. We expect more normalized and lower demand levels for in home consumption rest of year where Orkla has 75% of its turnover exposed. Focus on profitable organic growth and long-term value creation will require continued ANP investments in line with our strategy. And I would like to emphasize that although we talk a lot about some of our new growth platforms, it's very important to me that we dedicate enough focus and resources to our core brands and categories. Our brands have been chosen and loved by consumers for generations and we need to earn our place in the consumers basket. And we must never take that for granted. So we will continue our plans for strengthening our positions and at the same time pursue new growth opportunities such as plant-based out of home and health. Furthermore, Orkla has a strong culture for continuous cost improvement. We will nurture this also going forward with regards to new growth initiatives as well. I believe Orkla has good momentum. And I and the management team already for the challenges and opportunities ahead. And with that, we will now open up for Q&A, Kari.

[A - Kari Lindtvedt:]

Yes. Jaan Ivar. We have a couple of questions from the web. First out is Vincent Lee, three questions from Bernstein. I'll take them in one at a time. In the confectionary business, you talk about mixed market share performance driven by strong competition from international players and private label. Has the food business also been suffering from similar competition? And has that heard market share too.

[Jaan Ivar Semlitsch:]

I can start off. I think we've seen a similar picture in some areas in foods as well. And it's important to note that in Sweden, because of the Project 1 and our ERP launch there, we've had less campaign activity in Sweden this year, compared to last year where we have higher campaign activity. We expect more campaign activity now in Sweden, the second half as the ERP system now is up and running with good service delivery level and good customer feedback. But we are not commenting up on specific categories or specific brands in our [comps] [ph].

[Kari Lindtvedt:]

Thank you. Second question, can you give some more color on fixed costs. This is just the level of fixed costs has abnormally low levels last year despite margin through the peak of the stockpiling, can you explain why there would be an increase in fixed costs this year?

[Jaan Ivar Semlitsch:]

I guess I could start off and I will let Harald to continue. First of all, I would say that we've had higher activity level. And we also have more maintenance in our factories, as things now have opened up compared to quarter two last year. So important for me just to say that, and then there are some negative one offs this year and some positive one offs last year, and I guess Harald you have elaborated on that, but feel free to comment.

[Harald Ullevoldsæter:]

Yes, I think you mentioned the most important part last year was a normal low, with very low activity. Of course, activity has increased and will increase further during this year. So we are comparing against very low comparables in the fixed cost part. And this has had some one offs but the general picture is that the fixed cost level last year -- second half of last year was also normal low.

[Kari Lindtvedt:]

Thank you. And the final question from Vincent in Bernstein. Profit growth is already slowing in Jotun in Q2, are you expecting profits to be down in the second half?

[Jaan Ivar Semlitsch:]

While we don't comment upon Jotun or give any guidance as such. But of course, Jotun is facing also increased raw material costs. They are doing price mitigating actions, but we're not commenting upon the sort of Jotun outlook. But I am impressed by the performance in Jotun's first half, would like to say that in a very difficult situation still delivering solid profits.

[Kari Lindtvedt:]

Thank you. Then we have two questions from Charles Eden in UBS. First one, given the raw material headwinds you're facing, have you already begun price increase negotiations with customers? When would you expect these price increases to be seen in Orkla’s P&L?

[Jaan Ivar Semlitsch:]

So we don't comment on specific customers or specific markets, but we are doing the necessary actions. But there will be lag effects. And as I mentioned, we have a history of continuously working on this topic and we have strengthened our revenue management function. We did that two years ago. But I would say that it's more broad based and quicker increases in raw material price now than what we have seen before. And I suppose we would see all consumer goods companies. We see sugar prices up 40%. We see sunflower oil up 65%. Just as some examples and Harald also illustrated that with the sort of a broad

[Kari Lindtvedt:]

Sure.

[Harald Ullevoldsæter:]

So if the prices stays at this level for the second half, we will face some higher levels than we haven't before. Yes.

[Kari Lindtvedt:]

Yes. On food ingredients organic sales growth. Do you believe 20.5% organic sales growth is matched by sales to end customers. And you believe there is some inventory building from your customers in anticipation of higher demand as markets reopen?

[Harald Ullevoldsæter:]

That’s a very difficult question to be very precise, but we expected this is the more or less the underlying demand. We have to bear in mind that we have almost 20% reduction in the same quarter last year.

[Jaan Ivar Semlitsch:]

It’s a great question although a difficult one. I could also add that we've had fantastic ice cream weather during June is warmer now in July. But we have been very good at delivering with very good service levels from food ingredients. So it was a cold May. But everything opened up. And we've had the nice weather. It's been fantastic. We're from the food ingredients organization delivering all the ice cream. So hopefully we will have a nice weather in July as well.

[Kari Lindtvedt:]

Thank you. John Ennis, Goldman Sachs. Can you help bridge the margin performance for us in Q2? Can you quantify how much of the margin decline was driven by raw materials versus mix versus the ERP implementation? And what is the aggregate level of input cost inflation you are expecting in the year?

[Harald Ullevoldsæter:]

That's a very detailed question. But I can give some colors or flavor to that. As I said in my presentation, there are different elements last year and different elements this year that affect our profit. Looking at last year happening to see reversal of the accruals in confectionary and snacks as we mentioned last year. And of course, also the normal cost levels with very low activity. And of course, the quite high stockpiling effect in India with [indiscernible] quarter with more demanding situation. And this quarter we have the facing of the Easter, as I said, and, of course the increased cost to the ERP project in Sweden, where some of it is more like one-offs, but in total this sum off to more than the underlying reduction of 86 million for the quarter on EBIT.

[Jaan Ivar Semlitsch:]

I just would like to add on the ERP project that it's running very well. It's again, good service delivery, good customer feedback, but we've had some cost increases due to the launch and the implementation and that will continue during 2021.

[Kari Lindtvedt:]

Yes, thank you. Then, we have a question from Bruno Monteyne in Bernstein. You're not happy with profit conversion? Can you explain what you plan to do differently the next few quarters to improve performance.

[Jaan Ivar Semlitsch:]

We will continue our strategy, focus on profitable organic growth, investing in ANP as we have said before, to make sure that we stay on top on having the number one and two positions and that we gain market share. So and then we build some additional platforms and we are in the early days, but good momentum, both in plant based, in out of home and in health. So we will continue our strategy. But we will come back to more etails also when we have our capital markets day in November. And then, we are continuously reviewing the cost side of course, and as we open up and then we can also be more out in the factories. We are always looking through the supply chain agenda and mitigating factors on the cost side.

[Harald Ullevoldsæter:]

I think we will have some more even more focus on the cost improvements. And of course, we now more allowed to visit our factories. I guess that has been a negative impact over the last one and a half year.

[Kari Lindtvedt:]

True. Then we have three questions from Ole Martin and they seem to be the final ones from the web. One, how was the growth in Naturli and the number in the quarter?

[Jaan Ivar Semlitsch:]

Saw good growth in the quarter? Do you have perhaps the very details, Harald.

[Harald Ullevoldsæter:]

No, but I said quarter one that the top-line was almost flat and by first half year we have increased approximately 7% for our own brands not to [Technical Difficulty] which means that we have approximately 14% underlying in top line growth in the second quarter.

[Jaan Ivar Semlitsch:]

I could perhaps add as a fun fact that Naturli is now on the menu in all choice hotels in Norway. Again, that fun fact is, no big impact to the numbers, but it's part of building Naturli as a big brand in Norway. It's a big brand in Denmark already and [indiscernible] strong brand in Sweden. But we're also launching Naturli into the Swedish market as well.

[Kari Lindtvedt:]

Thank you. And then, well, Martin is wondering how was the growth in India?

[Harald Ullevoldsæter:]

No growth in India. That's for sure. Because he compared with a very, very strong second quarter last year. So it was quite a big profit decline in India. But we're not afraid it's coming back.

[Jaan Ivar Semlitsch:]

It's good performance in India, but we are comparing against the very strong numbers Q2 last year, with stockpiling and also with very good service level from our side where the competitors had less of that service level. So, yes, just to comment upon that.

[Kari Lindtvedt:]

Good. And then the final question, how much was the negative impact on margin from higher raw material costs year-on-year?

[Harald Ullevoldsæter:]

I don't think we go into those details Kari. But we have said that the raw material prices has increased but somehow it hasn't been offset by the currency development.

[Kari Lindtvedt:]

Thank you. That concludes the questions from the web. Thank you both Jaan Ivar and Harald. We will be back with the third quarter results on the 29th of October. Please also save the date for our Capital Markets Day on the 23rd of November this year. For those of you going on vacation, we wish you all a very nice and relaxing holiday. That wraps up today's session. Thank you all for joining.