Orkla ASA
Q4 2018 Earnings Call Transcript

Published: 6 Feb 2019

[Peter Ruzicka:]

Good morning everyone and welcome to today's presentation of the results of Orkla's Q4 but also full year 2018. In the first part of my presentation. I will go through and concentrate on the full year figures and Jens will go through the quarter more in detail after my first presentation. But first let's have a look at the highlights, at the highlights from 2018. I'll just want to say in the beginning that I am, of course, very disappointed about our performance in 2018. For sure, we had some headwind, but we cannot blame factors, external factors for all our setbacks in 2018. I know that we can do better than this and we will do better than this going forward. But of course, there also being some positive elements in our figures and in our operations. We achieved organic growth of 1.5% in foods despite quite strong headwinds in Norway. We will come back to this. Food Ingredients also delivered decent growth and also in food ingredients, we have exited some unprofitable areas. So, despite that they had some okay growth on top-line. But we have been through a tough year in care within some markets. And I will spend some more time on the specific issues in care in a few minutes. In confectionery and snacks, our performance has been impacted by the increased sugar tax in Norway which is now reversed in 2019 and of course of the loss of the Wrigley distribution agreement. Overall, our ongoing efficiency improvement program is progressing as planned. But due to challenges experienced in 2018, our organic growth and margin development were almost flat. And as I mentioned we are not happy about that. That is not satisfactory. During the year, we have also grown our brand consumer goods business through several attractive acquisitions. The largest one has been the Finnish number one beloved pizza brand Kotipizza. I'll come back to Kotipizza after Jens presentation and also talk a little bit about our out-of-home strategy and the rationale behind this acquisition. Earnings per share from continuing operation was down from last year due to significant increase in net non-recurring items from restructuring and also M&A activities. And the Board's intend to propose to the AGM dividend of NOK 2.60 per share. But that's mentioned we have had some serious, I would say issues in part of the care business and I would like to share some thoughts with you on this and some explanations. Care is our most diversified area and our largest units our home and personal care and our health business. In addition, care includes painting tools the Orkla House Care and other areas like wound care, carry bag and also professional cleaning solutions. In 2018, we experienced actually good progress in home and personal care in wound care and in carry bag but that was more than offset by decline in Orkla Health mainly in Poland and also continued problems in our health care business in the U.K. But as we addressed in Q3 presentation, the largest wholesalers in Poland have reduced their stockholding due to new principal. What we see is then that our sales towards the wholesalers is reduced drastically during 2018, but sales from wholesalers to the pharmacies and from pharmacies to end-consumer is not impacted. So we expect this sale to come back during 2019. In House Care U.K. a turnaround process is ongoing and we see positive momentum as we see that EBIT decline has bottomed out, I mean not slow start to see positive improvement in EBIT. And we also expect gradual improvement in House Care U.K. in 2019. But this business will continue to have a negative impact on top-line as we do a portfolio restructuring. But the bottom-line shall improve during 2019. So, let's have a look at our overall organic progress and also by business area. As I mentioned we have had decent organic growth in foods and food ingredients, but that was offset by issues in care that I just described. And of course, the sugar tax impact in Norway. And our overall organic growth in 2018 was clearly too weak. But, if you look at our key markets we continue to see stable, but of course moderate growth in our main markets. If you look at the Nielsen figures, average grocery retail per Q3 2018 showed that growth of approximately 2% in the Nordics and slightly higher in the Baltics and Central and Eastern European markets. That growth varies a lot by category. Across our Nordic markets, we have seen strong growth in beverages and frozen food mainly in ice cream. These are categories where we have little presence. And we have seen very weak growth in some non-food categories such as HPC where there is a clear channel shift from traditional grocery retail to specialty discounters and online. And we are very big in some of these categories. So that really hurts us on our top-line. But on the other side, we are also increasing our focus on other channels with higher growth. We estimate that average growth across Orkla's categories and markets reach 2% in 2018. But of course, it's important not only to look at averages, we have had strong growth in most business areas in the Nordics with the exception of Norway and we have had quite strong growth in Central Europe. And the key negatives are already known as you have seen, its lower confectionery volumes in Norway due to sugar tax. Its weak growth in our Norwegian foods portfolio partly due to lower retail campaign, but also increased substantially increased retail prices in some of our main SKUs. And of course, the negative impact of health in Poland and house care in U.K. As we mentioned in our Capital Markets Day in London in October, our target is still to grow at least in line with the markets where we operate over time. But we also pointed out in London, our focus at least short-term will be to reduce complexity and we have had high priority reducing complexity and improving margin than improving top-line in the short-term perspective. We will come back to this topic during 2019 and to show you the progress how we are doing on margin improvement and complexity reduction. So I will now give the words to Jens, who will go through the quarterly performance and the figures and then I will come back to our acquisition in Finland and also summing up the year. Thank you so much.

[Jens Bjørn Staff:]

Thank you, Peter. Let me first go through the development on the branded consumer goods top-line growth. I'm looking at the fourth quarter, top-line growth in branded consumer goods was flat. Structural growth was offset by negative currency translation effects as well as negative organic growth and compared to a close to 3% organic growth in Q4 last year. Organic growth was flat or minus 0.2% when adjusted for this lost Wrigley distribution agreement. And as you remember the Wrigley distribution agreement is out of the comparables from January 19. Good growth in foods was overshadowed by negative volume effects in conjunction with the sugar tax and the issues in health that Peter has already mentioned earlier. I'll revert to more to the details on these matters a little bit later on. M&A added the growth of 2.4% and that's primarily driven by the acquisition of HSNG as well as several add-ons in food ingredients. On the opposite side, we have negative effects of the divestments that we have done, K-Salat's is the main explanation. Let's look more at the development for the branded consumer goods including H2 when it comes to EBIT and margin. It's been clearly a weak quarter when it comes to EBIT underlying EBIT development with a negative development of 3.5% on a like-for-like basis. And you recall an exceptionally strong Q4 last year where we saw double-digit earnings growth also on a like-for-like basis. So it's quite tough comparables. It's been a mixed development among the segments. OFI has shown both strong margin and EBIT development driven by operational improvements and better pricing improvements. Health has been the clearest negative factor and that's been as Peter said a clear disappointment for us this quarter. Orkla Foods saw a temporary weakening of profitability with negative timing effects compared to last year. I'll come back more to the BA specifics in a minute. Looking at underlying margin development. The trend that you see here is clearly too weak. Our ongoing efficiency initiatives is of course an important driver of margin improvement. And we continue to execute our programs as communicated on the Capital Markets Day. The progress is according to plan, but the progress is not strong enough to compensate for the short-term challenges that we met in 2018. As Peter said, we expect this trend to recover during 2019 as issues in care begin to normalize. And the sugar tax effects on the Norwegian confectionery market starts to normalize. Let's look more at the BA specifics. Orkla Foods delivered strong organic growth. And the organic growth was supported by improvements in all markets except Denmark, where we have deliberately exited some low profitable business. I'm glad to see that Norway for the first quarter shows organic growth of the three rather disappointing quarters. However, did this good sales growth that we saw didn't lead to any EBIT improvements. And the EBIT dropped caused by several factors divestments it was factory-related projects and non-recurring year-end items, but the delta is the main negative effect. And this was especially in Norway. In addition to this, of course, affecting the contribution margin on the contribution ratio, the foods continues to see strong headwind on real effects from the currency situation where the Swedish kronor and the Norwegian kronor, as you know has slipped back against the euro. These effects in some led to a weak margin in Q4, raised the margin trend for the overall year is positive. Let us look at the confectionary and snacks. Of course, the loss of the distribution agreement with Wrigley and the sugar tax in Norway continued to hamper the progress in confectionary and snacks also this quarter. If we look at organic growth outside Norway it's 2.5% for 2018. Sales in Q4 were negatively impacted by destocking ahead of the reversal of the sugar tax in Norway. And we have seen volumes coming back in the start of 2019. We saw a decline in EBIT because of this revenue drop. And also in confectionary and snacks, EBIT and the margin was affected by negative real effects from currency. And higher energy prices especially in Sweden. Our ongoing cost improvements in confectionery and snacks is also progressing according to plan and contributing positively. Let's look at the care business area. Peter described this area and the challenges a little bit earlier in the presentation. Good organic growth in Orkla Home personal care and other care categories was more than offset by the decline described in health Poland and House Care in U.K. the Harris business. We saw improved figures in Q4 in many markets in Orkla Home and Personal Care especially Sweden even compared to a very strong Q4 last year. That also goes for wound care especially in the Scandinavian part of wound care. In some EBIT in Orkla Care was negative by 8.4%, the decline was caused by health and Specialty Health Poland. Reported growth outside in the care businesses, outside Health Poland was close to 10% in Q4. Margins were down 140 bps in the quarter because of the sales decline. Higher input costs and dilutive effect from M&A. Lastly, lets look at Orkla Food Ingredients. EBIT in the food ingredients improved nicely. The progress was related to increased sales profitability on the sale of bread improvers and mixers. And in addition, we have taken actions to lift margin and have good progress on the turnaround projects in food ingredients. The drop that we see in organic growth is partly caused by deliberate actions to exit low profitable sales. I mentioned that the vegan portfolio, Naturli's portfolio that we've talked about many times to the markets are continuing to develop very healthy. So we see continued sales growth of 40% and that's due to improved innovations and a much broader customer base. Let's look at this figure that is going to be shown more and more often. And it represents the level and the ambition on the net working capital side. And we will revert to the market once or twice a year. Talking about the actions that we have implemented or going to implement to reduce the level of current capital. And this is a rolling 12 months figures, of course, it will take time to see the real effects on these numbers, but we'll talk about the actions implemented and keep you posted. The rolling 12 months the level is still at 13%. And as you can see on this graph we aim to reduce it down to 10% by the end of 2021. Let's look at the CapEx. And in 2018, we invested NOK 1.9 billion in total CapEx, which corresponds to approximately 4.9% on net sales. Maintenance level is relatively stable at the level of NOK 1.1 billion or approximately 3% of net sales. The ambition is that the maintenance investment level should be slightly below the level of depreciation. As we talked about on the Capital Markets Day, we are currently spending more investments on the ongoing ERP program. And some expansion investments related to factories. So the majority area of the delta between the maintenance and the total is then -- investments in ERP and expansion. Amongst others, this new pizza factory that we are building in Norway. CapEx is expected to be in the range of 4% to 6% of net sales for the coming 3 to 4 years as we talked about on the Capital Markets Day. This will of course affect the cash flow but we expect to have positive cash flow effects from realizing real estate development projects as well as selling of some plants or properties in conjunction with the factory closure program that we are doing. In addition as you saw on the last slide, we are aiming for realizing or freeing up cash from being much more effective on the current capital side. So in sum, this will have a positive effect on the cash flow. Let's turn to Jotun. The development in Jotun is continuing as communicated in Q3 and on the Capital Markets Day by Morten Fon. That means there's good top-line momentum especially from the decorative and protective segment. Marine segment is still affected by the cyclical downturn, but are showing some progress in Q4. Raw materials have stabilized and together with already implemented the price increase actions this have slowed down the negative effect that we've seen on the gross margins. So going forward, Jotun expects still good progress within the decorative and protective segments. Jotun are expecting a gradual pickup of the performance on the marine segment side in the latter part of 2019 and if we have this development that we've seen lately on the raw materials side, and then, put in addition already implemented price increase actions. Then the gross margin should stabilize and gradually pick up. For further details regarding Jotun figures they will represent their full year accounts on Monday, 11 February. So then Jotun will disclose more information. The last slide I will sum up some of the important financial items and more details on the investment division. And as you know reported earnings from the branded consumer goods spot including HQ was a negative by 5%. On a like-for-like basis we are down underlying EBIT -- development we were down 3.6% or 3.5%. Earnings from hydropower was record high, it was substantially higher than last year because of the higher power prices that we've seen. We had non-recurring items this quarter of close to NOK 300 million. And as you know this line item will vary from quarter-to-quarter depending on the activity of restructuring and M&A and so on. This quarter for obvious reasons there were several major items that were booked and I'll give you now some more detail on these items which constitutes or approximately two-thirds of this NOK 300 million. As you know we are doing some restructuring -- quite significant restructuring in U.K. Harris; the Harris business there and in conjunction with that some write down of inventory. In addition, some provisions for this restructuring activity. In some this accounts for around NOK 50 million that is done in U.K. Harris. And then, there's been layoffs of sales force in Norway. As you know two of the retailers are taking over merchandising from 2019 that affects a lot of people in Orkla. And we have taken costs in conjunction with this decision that the customers made. So a part of the provisions made or the cost in the Q3 on other income and expenses is related to that. We also had M&A related costs this quarter of around NOK 40 million and as you remember we have shut down vegetable production factory in Finland moving the production to Sweden and Czech Republic. The cost of this closure was around NOK 60 million part of it is write down of assets and part of it is other provisions for redundancy and so on. The remaining one-third of other income and expenses costs this quarter is spread across the other business areas unrelated to the restructuring activities that we've done. So, there's been a lot of restructuring activities, a lot of M&A activities and that is the story of Orkla as we are today. Last year, as you remember, we reported almost zero on the same line item, so the delta between the years, of course, are very, very huge. As you remember, last year, we booked income from sales of companies of over NOK 200 million. So looking at the line item other income and expenses, on a full year basis year-on-year and adjust for these big sales that we did last year, the level is approximately on the same level. This year, we have sold off 2 parts that were booked on this line item in the quarter, that is Mrs. Cheng, and we have a sales agreement of the nut business in Russia, the Chaka, and that net effect there was slightly positive. Our tax rate is also higher this quarter than last year, and the main driver for this higher tax rate is the good result in Hydro Power. And as you know, there are special taxes for Hydro Power in Norway, which we call resource rent taxes that are higher than the underlying tax rate for the Branded Consumer Goods part. So that's the main explanation. In sum, of course, this has a very negative effect on the earnings per share on a year-on-year basis. And earnings per share was down 23% compared to the same quarter last year. Okay. Then I'll hand the floor back to Peter for his update on our Kotipizza tender offer.

[Peter Ruzicka:]

Thank you, Jens. So, let's talk about something more positive than our Q4 results. Our out-of-home strategy and our acquisition of Kotipizza, as I promised you earlier today. Well, so why is this an important move for Orkla? Why are we looking at out-of-home? Well, several reasons, but I think the main reason is that we see a very strong and consistent growth in the Nordic out-of-home business. And the growth is increasing, and we see a growth at least 3x higher than what we see in traditional food retail. According to our estimates, we think and we believe that approximately one-third or even more than one-third of the total consumption of food and beverage is consumed outside the home, it's in the different out-of-home channels. And as you know, food is the largest business area and the largest categories in Orkla, and that's what makes out of home a natural part for Orkla's strategy. We need to be present where the consumers are. We need to be present where the consumer expect to find our products and where they consume food and that is changing more and more to other channels than at home or traditional food grocery stores. And out-of-home is actually not a new business for Orkla. We have been in out-of-home in different areas of out-of-home for many, many years. And actually, 20% -- approximately 20% of our total turnover comes from the out-of-home channel. That is in food service, it's in HoReCa, but it's also special out-of-home brands. We have products and we have brands present across many, many different channels in the out-of-home area. And we also have several specialized companies focusing only on out of home, for instance, Nordic ice cream Nic, our ice cream ingredients business, is only delivering to the out-of-home channel. And actually, we are also an important innovation partner for some leading out-of-home players like Anamma, vegan burger in McDonald's in Sweden. And we will have a differentiator -- obviously, we have a differentiated approach to how to strengthen our position in the out-of-home channel. That will be different from market to market and from channel to channel and category to category. And of course, acquiring an out-of-home concept that's new to Orkla, it's a different business model than our core. However, acquiring and building strong brand is very much part of Orkla's DNA. That's what we have done for decades. So why Kotipizza? Well, Kotipizza is the strongest pizza brand in Finland by far. They have a 20% market share for branded pizza across all channels, also frozen pizza, take-away, out of home, everything. It is preferred brand by Finnish consumers. And actually, they have previously been awarded the world's best pizza back in 2012. That's quite impressive. We also see that Kotipizza has a strong fit with Orkla. Pizza is one of our core categories. It's one of our largest product categories and it's a category where we have experienced high growth over many, many years. And Kotipizza is really complementing our pizza strategy in Finland. And where we are today in Finland? We are only present in the frozen pizza area, which accounts for only 12% of the total pizza consumption in Finland. So, in order to be a big player in pizza in Finland, we need to go into the out-of-home area to be a big player, and that's what we are now doing with the strongest brand in Finland. Kotipizza is an integrated out-of-home player. They have a specialized out-of-home both sourcing and logistic company, very efficient, serving mainly Kotipizza, but also serving some third-party customers. They have the largest out-of-home pizza concept in Finland, but they also have some smaller fast casual concepts that we believe we can continue to develop. They have a proven track record. They have increased sales in their Kotipizza chains for 45 consecutive quarters, quite impressive. And as I said, out-of-home business model is, of course, it's new to Orkla. We know the out-of-home business but not that exact business model. But through the acquisition of Kotipizza, we have acquired a very experienced and a very proven management team to support our journey going forward. And we will, of course, also have a strong cooperation between Kotipizza and the management team and our local management team in Orkla Suomi to strengthen value creation going forward. At Kotipizza, they have a long track record of defining and delivering on their strategic agenda. They have really an impressive history. And going forward, the value creation will be centered around 3 main dimensions to benefit both from Orkla and the franchisees. Of course, to grow the core is the most important thing, grow Kotipizza sales through existing restaurants, but also opening new restaurants and grow the food stock business, the distribution logistic business. Then also realize potential from smaller concepts, the smaller concept that I mentioned, the Social Burgerjoint, No Pizza, Chalupa and so on. And of course, also realize top and bottom synergies with Orkla. However, this is -- of course, it's early days and we will spend the next months reviewing the strategy together with the management of Kotipizza together, of course, with the franchisees of Koti. So, before we go to Q&A, I would like to sum up our main messages today. And I think as I started the presentation, 8

[Q - Preben Rasch-Olsen:]

Carnegie, Preben. Quick question on the Norwegian operations. You just done the annual negotiations with the Norwegian retailers. Can you sum up on your thoughts on how that went and do we see growth in Norway in the coming year?

[Peter Ruzicka:]

No, I will not comment on that. I will not comment on our negotiation and relationship with specific customers. But what I can say is only that this is more or less according to what we have experienced historically.

[Preben Rasch-Olsen:]

Question about the Koti acquisition. Is it the first time the company have waiters as human resources?

[Peter Ruzicka:]

Pardon, first time we have?

[Preben Rasch-Olsen:]

[Foreign Language]

[Peter Ruzicka:]

Yes. The question is actually then about having waiters and how that impact our HR work and so on. Well, we acquired Gorm's or a majority part of the Gorm's pizza in Denmark last year, so we have some experience from that. And of course, operating restaurants is different than operating Branded Consumer Goods. On the other hand, there are also lots of similarities. Koti is 100% franchised, so there are independent franchisees operating the restaurants. So we are delivering -- Koti is delivering the concepts, the recipes and the marketing and so on. So Kotipizza will not be operating the restaurants that will be done by the franchisees. And of course, there are big differences, but there are also similarities and this is about being close to the local consumer, understanding local consumer and making offers, recipes, tastes, offers in restaurants and so on that meet the consumer needs and expectation. And that's an area where I think we have a lot of knowledge in Orkla.

[Thomas Ljungqvist:]

Yes. We have a couple of questions from the web as well. Petter Nystrom from ABG, he has 2 questions. First one is, is it possible to quantify the destocking effect in Confectionery & Snacks?

[Jens Bjørn Staff:]

Of course, this is hard to be very precise on. But as we see it, the destocking effect represents around 2% organic growth for the Confectionery & Snacks area in Q4.

[Thomas Ljungqvist:]

Okay, thank you. The second question is, did I understand it correctly that the EBIT margin decline for Foods in Q4 should be viewed as temporary meaning it's not representative for the speed going into 2019?

[Jens Bjørn Staff:]

Can you please repeat, Thomas?

[Thomas Ljungqvist:]

Whether the margin decline in Foods in Q4 is representative going into 2019 and whether it is temporary.

[Jens Bjørn Staff:]

It's not representative.

[Thomas Ljungqvist:]

Okay. We also have a question from [Seamen] [ph] at DNB. He's asking a little bit about the other income and expenses of NOK 300 million or NOK 296 million to be precise. If you can elaborate a little bit on what they were and also what we should expect going forward.

[Jens Bjørn Staff:]

As I said, this line item will vary from quarter-to-quarter. It's the nature of this other income and expenses. And then last year, we had a lot of sales gains that brought it close to zero. This year, in this quarter, we have had especially high, I would say activity when it comes to M&A and restructuring. And first of all, I said that we are continuing the restructuring of the U.K. Harris business to turn this around. And in sum, we made write-offs of inventory and provisions of NOK 50 million. Then 2 of the Norwegian customers have said that they will take back merchandising from Orkla. That means a lot for a lot of our employees in conjunction with this decision by the customers, we have made provisions for redundancy in our accounts. Then we closed down our production facility producing vegetables in Finland, moving the production to Sweden and Czech Republic. In sum, that closure represents NOK 60 million of the other income and expenses this quarter. So, these major items represents around two-thirds of the cost that we saw this quarter. Then you add on the M&A activity, which is around NOK 40 million in cost. And then, we sold-off some businesses this quarter. We entered into sales agreement of the Russian nut business, Chaka and then also sold Mrs. Cheng, but the net effect of these two transactions were only slightly on the positive side. And then there's, of course, cash cost there. And the sum of the other income and expenses in Q4, two-thirds of it is cash cost. Going forward, of course, the activity on this line item will vary from quarter-to-quarter. And as I said in my presentation, we are doing a lot of M&A, we are doing a lot of restructuring. Some of these costs will end up on the other income and expenses. At the same time, as communicated on the Capital Markets Day, we are aiming to looking really tough on our portfolio, challenging the relevance of several categories and are going to then, as a consequence of that, most likely also sell-off businesses that will be booked on other income and expenses. The main message there is it still varies. What we've said earlier is that on a yearly basis, to be around NOK 400 million. But as I said, this will vary.

[Thomas Ljungqvist:]

All right, more questions. This time from John Ennis at Goldman Sachs. His first question, I think you already answered, it's about restructuring guidance for the next three years in conjunction with the margin improvement targets, but I think that's already been answered. The second question is, if you can bridge the associates line for us, given that Jotun had a positive performance in fourth quarter, can you explain what was the drag that made the profit from associates NOK 40 million negative?

[Jens Bjørn Staff:]

The main item on this slide is Jotun. The other parts are just minor. So and as I said, Jotun will revert more on the details of their performance when they present their year-end results on the 11February.

[Thomas Ljungqvist:]

Okay. His last question is, can you elaborate on what the growth in Orkla Care was, excluding the Poland destocking impact?

[Jens Bjørn Staff:]

Yes. As I said, if you exclude the negative Polish effect on the Care EBIT growth, reported EBIT growth would have been 10% for the quarter.

[Thomas Ljungqvist:]

Right. I have another question from Ole Martin Westgaard at DNB. Can you give any flavor on how we should think about organic growth in Care in the coming quarters given the restructuring on Harris? Furthermore, what is your expectation with regards to the timing of Easter effect on Q1?

[Jens Bjørn Staff:]

I will start with the latter one, on the timing effects of Easter is that if you look at the two quarters coming now, Q1 will have one more, call it, sales day and Q2 will have two less sales days. But when it comes to the Easter, Easter starts in Norway at the 18th of April, so that's quite late. So, we assume that sort of presales in front of Easter will most likely then move into Q2. So that's a quite brief comment on that. And then remind me of the first question.

[Thomas Ljungqvist:]

It was if you can give any flavor on how we should think about organic growth in Care in the coming quarters given the restructuring on Harris.

[Peter Ruzicka:]

Yes. As we mentioned, we are doing a quite big restructuring in Harris, changing as to the whole portfolio. That will have a negative impact on organic growth also in 2019, but will have a positive impact on EBIT in Harris. We should expect continued negative top line development, but positive bottom-line improvement. When it comes to Orkla Health, we also expect that the stock reduction at the wholesalers in Poland will be more or less over during 2019. So, we will see that both sales and profitability will come back during 2019, probably in the second, third, fourth quarter in Orkla Health.

[Thomas Ljungqvist:]

Thank you.

[Peter Ruzicka:]

Okay. No further questions? Difficult to see. Okay. Thank you, everybody, for coming and spending the time with us here today and look forward to see you after Q1 presentation again in our new head office.